HOLDERS  OF  RAILROAD 
BONDS  AND  NOTES 


LOUIS  HEFT 


JOSEPH  1.  IEWINSON 


THE  LIBRARY 

OF 

THE  UNIVERSITY 
OF  CALIFORNIA 

LOS  ANGELES 

SCHOOL  OF  LAW 
GIFT  OF 

Mr.  W.   Stratton 


HOLDERS  OF  RAILROAD 

BONDS  AND  NOTES: 

THEIR  RIGHTS  AND 

REMEDIES 

Treating  Particularly  of  the  Re- 
ceivership and  of  the  Reorgan- 
ization of  the  Road,  of  the 
Foreclosure  of  the  Mortgage 
and  of  the  other  Proceedings 
to  Realize  on  the  Security. 


BY 

LOUIS  HEFT 

OF  THE  NEW  YORK  BAR 


NEW  YORK 
E.  P.  BUTTON  &  COMPANY 

681  FIFTH  AVENUE 
1916 


T- 

6.I 


Copyright,  1916 
BY  E.  P.  BUTTON  &  COMPANY 


TO 

THE   MEMORY  OF 

MY  FATHER 


PREFACE 

It  is  fairly  safe  to  say  that  the  great  majority  of  \ 
the  holders  of  railroad  bonds  and  notes  never  read 
their  securities  nor  the  mortgage  that  secures  them. 
It  is  only  when  the  railroad  company,  whose  securi- 
ties they  hold,  becomes  insolvent  or  defaults  that 
they  seek  advice  as  to  their  rights.  Then,  quite  gen- 
erally, for  the  first  time,  they  ask  for  a  better  under- 
standing of  the  nature  of  their  securities;  of  their 
rights  as  to  the  other  creditors  and  the  property  of 
the  road;  of  their  probable  relations  with  their  trus- 
tee, the  receiver,  and  the  reorganization  committee. 
The  foreclosure  and  the  receivership,  that  usually 
follow  the  insolvency  of  a  railroad  company,  and 
the  reorganization  of  the  road,  that  is  invariably 
attempted,  present  many  situations  that  affect  its 
security-holders,  of  which  they  should  have  at  least 
a  fair  understanding. 

Recent  governmental  investigations  have  pointed 
clearly  to  the  extreme  ignorance  of  the  investing 
public  as  to  their  rights  as  holders  of  corporation 
securities.  It  is  hoped  that  the  information  con- 
tained in  these  pages  may  help  to  a  better  under- 
standing of  the  nature  of  railroad  securities  and  of 


PREFACE 

the  rights  and  remedies  they  confer  on  their  holders, 
and  that  such  knowledge  may  help  to  safeguard 
investments. 

L.  H. 
New  York,  October,  1915. 


LIST  OF  CHAPTERS 

CHAPTER  PAGE 

I    INTRODUCTORY     i 

II    RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  VARIOUS 

KINDS  OF  RAILROAD  BONDS  AND  NOTES 8 

III  RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  MORTGAGE 

OR  DEED  OF  TRUST 56 

IV  RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  TRUSTEE- 

SHIP   116 

V  RIGHTS  AND  REMEDIES  WITH  RELATION  TO  FORECLOSING 
THE  MORTGAGE  OR  OTHERWISE  REALIZING  ON  THE  SE- 
CURITY   146 

VI    RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  RECEIVER- 
SHIP OF  THE  RAILROAD  COMPANY 187 

VII  RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  ASSETS  OF 
THE  INSOLVENT  RAILROAD  COMPANY;  RIGHTS  AND 
PRIORITIES  OF  THE  OTHER  CREDITORS 227 

VIII    RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  REORGAN- 
IZATION OF  THE  RAILROAD  COMPANY 335 


vii 


CONTENTS  OF  EACH  CHAPTER 


PAGE 

INTRODUCTORY i 

Three  values  of  a  railroad  security — Market  value — In- 
trinsic value — Legal  value. 

II 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  VARIOUS  KINDS  OF 

RAILROAD  BONDS  AND  NOTES 8 

General  description  of  railroad  bonds,  notes  and  deben- 
tures ;  notes  and  bonds  compared ;  power  of  railroad  com- 
pany to  issue  same;  temporary  bonds — Transfer  of  bonds — 
Difference  between  bondholders  and  stockholders — Bond- 
holders are  bound  by  the  terms  of  the  bond  and  mortgage 
— Validity  of  bonds;  over-issue;  defective  issue;  issue  in  ex- 
cess or  abuse  of  power;  issue  in  violation  of  law  or  without 
power ;  secured  by  void  mortgage — Many  kinds  of  railroad 
bonds;  classified  generally  as  to  form,  security,  purpose  of 
issue,  and  mode  of  retirement;  distinctions  pointed  out — 
Rights  of  bona  fide  holders  of  negotiable  bonds  or  notes — 
Lost  or  stolen  coupon  bonds  or  notes,  or  coupons — Altered 
or  mutilated  bonds  or  notes  or  coupons — Coupon  bonds 
and  coupons — How  transferred;  clear  or  marked  bonds; 
presumption  of  ownership — Effect  on  coupons  when 
severed  from  their  bonds  or  notes — Collection  of  cou- 
pons— Presentation  of  coupons  for  payment;  dispensing 
with  presentation;  effect  of  non-presentation — Effect  of 
payment  on  coupons;  cancellation — Overdue  coupons; 
effect  on  bonds — Interest  on  overdue  coupons;  at- 
tached and  detached;  rates  of  interest  allowable — The  se- 
curity for  the  coupons;  priorities  and  preferences — Rights 
of  coupon  holders  as  to  each  other;  bona  fide  holders  of 
coupons — Statute  of  limitations;  as  to  bonds;  as  to  cou- 
pons— Registered  bonds ;  act  of  registration ;  effect  thereof 
on  principal  and  interest — Transfer  of  registered  bonds; 
converting  registered  bonds  into  coupon  bonds ;  payment  of 
interest — Registration  of  coupon  bonds  as  to  principal  only 
— Registration  of  both  bond  and  coupons — Interchangeable 
or  convertible  bonds. 

ix 


x  CONTENTS 

III 

PAGE 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  MORTGAGE  OR 

DEED  OF  TRUST 56 

Purpose  of  the  mortgage  or  deed  of  trust — General  de- 
scription of  the  mortgage — Power  of  railroad  company  to 
mortgage  its  property  and  its  franchise  to  operate;  opinion 
of  counsel — The  lien  that  the  mortgage  gives  the  bond- 
holders; liens  generally  discussed — Recording  the  mort- 
gage— Valid  bonds  as  affected  by  defective  mortgage; 
void  bonds  as  affecting  the  mortgage — Defective  mort- 
gages; partly  defective — Synopsis  of  railroad  mortgages — 
(a)  Parties  to  the  mortgage;  purposes  of  the  mort- 
gage—  (b)  Consents  of  stockholders,  directors,  public 
commissions  to  the  issue  and  to  the  mortgage — (c) 
Amount  of  the  issue;  limitations;  protection  against 
over-issue;  closed  mortgages;  open-end  mortgages;  open 
mortgages — (d)  Description  of  the  bonds  of  the  issue — 
(e)  Direct  obligations  of  the  railroad  (issuing)  company; 
stockholders,  directors,  officers,  protected  from  liability  for 
the  issue — (f)  The  property  is  transferred  to  the  trustee  to 
secure  the  issue,  upon  certain  conditions,  etc. —  (g)  The 
railroad  company  remains  in  possession  of  the  mortgaged 
road  and  other  property,  except  securities,  and  agrees  to 
keep  the  same  in  good  condition,  etc. —  (h)  Insurance 
against  loss  by  fire,  etc. —  (i)  Description  of  the  mort- 
gaged property — (j)  After-acquired  property — (k)  The 
railroad  company  agrees  to  preserve  the  Hen  of  the  mort- 
gage—  (1)  Execution  of  all  papers  necessary  to  facilitate 
the  trust;  waiving  redemption  and  exemption  laws,  etc. — 
(m)  The  rights,  remedies,  powers  and  liability  of  the 
trustee,  etc.;  trustee's  certificate — (n)  Provisions  as  to  pay- 
ment of  principal  and  interest;  free  from  all  taxes;  gold 
coin — (o)  Priorities,  if  any,  between  principal  and  in- 
terest; canceling  paid  coupons — (p)  Sinking  fund  arrange- 
ments—  (q)  Redeeming  bonds  or  calling  bonds  in — (r) 
Payment  of  serial  bonds;  bonds  issued  in  series — (s)  Re- 
funding plans — (t)  Provisions  for  converting  bonds  into 
capital  stock  of  the  railroad  company — (u)  Re-possession 
by  the  railroad  company  of  the  road  after  receivership  or 
possession  by  the  trustee — (v)  Remedies  to  enforce  the 
mortgage. 

IV 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  TRUSTEESHIP     .  116 

Relation  between  bondholders  and  noteholders  and  their 
trustee  generally — Reasons  for  trusteeship — Who  are 
chosen  as  trustees — Courts  hold  trustees  strictly  to  their 
duties — Liability  of  trustee  to  holders  of  bonds  and  notes 
secured  by  the  mortgage;  limitation  of  his  liability;  acts  of 
representatives;  losing  rights  against  trustee;  liability  of 


CONTENTS  xi 

PAGE 

trustee  to  third  persons;  indemnity  to  trustee — Holders  of 
bonds  and  notes  are  bound  by  the  official  acts  of  their 
trustee — Remedies  of  holders  of  bonds  and  notes  against 
their  trustee;  money  damages;  injunction;  removal;  com- 
pelling performance  of  certain  acts — Co-trustees;  major- 
ity; liability  of  co-trustees  for  acts  of  each  other;  succes- 
sion by  continuing  trustee — Trustee  may  not  delegate  to 
others  the  powers  requiring  his  individual  skill;  details 
only  may  be  delegated — Personal  interest  of  the  trustee 
in  the  mortgaged  property  forbidden  when  antagonistic 
to  holders  of  the  bonds  and  notes  under  the  mortgage;  pur- 
chase of  trust  property  by  trustee;  remedies  of  bond  and 
note  holders;  acceptance  or  rejection;  waiving  or  losing 
remedies  against  trustee — Litigation  is  conducted  by  the 
trustee;  holders  of  bonds  and  notes  are  then  bound  by  the 
decisions  of  the  courts;  appearance  by  bondholders;  in- 
demnity and  demand  by  a  certain  proportion  of  holders; 
when  trustee  loses  right  to  litigate — Bondholders  or  note- 
holders may  conduct  litigation  instead  of  trustee;  one  or 
more  sues  for  all;  all  then  bound  by  decisions  of  the  courts 
— Holders  suing  on  individual  holdings;  recourse  to  se- 
curity; provisions  barring  suits  on  individual  holdings — 
Selection  of  the  trustee;  general  scope  of  his  powers — 
Duties  of  the  trustee  generally;  duties  before  default  by 
the  railroad  company;  duties  after  such  default;  the  reme- 
dies the  trustee  pursues — Discretion  of  the  trustee  in  carry- 
ing out  the  details  of  the  trusteeship— Trustee  seeking  ad- 
vice of  the  court;  advising  with  legal  counsel;  guided  by 
the  opinion  of  the  holders  under  the  mortgage;  rights  of 
majority  of  holders;  rights  of  minority — Removal  of 
trustee  at  option  of  holders;  by  the  court;  for  cause — 
Resignation  by  trustee — Provisions  for  resignation  by  trus- 
tee; filling  vacancies  in  the  trusteeship — Compensation  of 
the  trustee;  fixed  by  mortgage  or  agreement,  or  the  court — 
Expenses  of  the  trusteeship ;  compensation  and  expenses 
paid  by  the  railroad  company  or  out  of  the  trust  property; 
contribution  by  holders;  expenditures  for  large  or  limited 
amounts,  or  for  certain  purposes;  lien  of  trustee  for  com- 
pensation and  expenditures. 


RIGHTS    AND    REMEDIES   WITH    RELATION    TO    FORECLOSING   THE 
MORTGAGE  OR  OTHERWISE  REALIZING  ON  THE  SECURITY    .  146 

The  three  usual  remedies  to  realize  on  the  security — 
When  the  right  to  commence  proceedings  accrues;  what 
constitutes  a  default;  in  interest;  in  principal — Reasons  for 
postponing  action  by  the  trustee  or  the  holders — Principal 
may  fall  due  upon  default  in  interest;  when  it  does  not; 
option  of  holders  to  declare  principal  due — Default  may  be 
waived;  rights  of  trustee  and  of  majority  of  the  holders  to 


xii  CONTENTS 

PAGE 

waive  defaults  of  the  railroad  company — Redemption  of 
mortgaged  road  by  the  railroad  company  and  its  re-posses- 
sion— Possession  and  operation  of  the  mortgaged  road  by 
the  trustee;  lease  of  the  road;  operation  optional  with 
trustee  or  holders;  rights  and  liabilities  of  trustee  while 
operating;  income  during  this  period;  distribution  of 
monies  received  by  trustee;  his  duties  while  operating  the 
road;  expenses,  contracts,  repairs,  supplies  and  help  in- 
cidental to  operation;  contracts  of  the  railroad  company  as 
affecting  the  trustee;  liability  of  trustee  for  negligence  of 
employees  while  operating — Trustee  selling  the  mortgaged 
property  to  satisfy  claims  under  his  mortgage;  exercise  of 
this  power  may  be  within  the  discretion  of  trustee  or  con- 
trolled by  holders;  details  of  such  sale — Foreclosure;  out- 
line of  procedure — Foreclosure  by  trustee  generally;  may 
be  controlled  by  holders;  rights  of  majority  of  holders  and 
of  minority;  foreclosure  by  holders  instead  of  trustee — 
When  foreclosure  sale  had — Entire  road  sold  as  one  in- 
stead of  in  separate  parcels;  foreclosure  for  interest  only; 
lease  instead  of  sale;  when  divisions  are  separately  mort- 
gaged ;  mortgages  on  constituent  roads  of  consolidated 
company — Combinations  to  purchase;  reasons  therefor; 
combinations  of  holders  under  the  foreclosed  mortgage  with 
others;  rights  of  non-participating  holders — Persons  barred 
from  purchasing  at  the  foreclosure  sale;  persons  who  may 
purchase — Rights  of  purchasers;  title  acquired;  the  fran- 
chise to  operate;  a  distinction  pointed  out — Standing  of 
purchaser  at  foreclosure  sale — Liability,  if  any,  of  pur- 
chaser or  new  corporation  for  debts  and  contracts  of  the 
railroad  company;  for  mortgages  and  other  liens  against 
the  property;  sale  subject  to  or  free  of  such  mortgages  or 
other  liens;  transferring  liens  to  proceeds  of  sale — Pur- 
chasers as  affected  by  debts,  contracts,  and  certificates  of 
the  receiver — Effect  of  foreclosure  on  claims  of  general  or 
unsecured  creditors ;  on  subsequent  mortgages  and  other 
liens;  on  claims  of  the  holders  of  the  bonds  or  notes  under 
the  foreclosed  mortgage;  on  prior  mortgages  or  other 
liens;  certain  liens  having  priority;  equity  of  redemption — 
Time  and  place  of  foreclosure  sale;  notice  of  sale;  ad- 
journment— Preventing,  stopping  or  setting  aside  the  sale; 
reasons  therefor;  losing  rights  by  delay,  by  participation; 
effect  of  setting  sale  aside — Terms  of  sale;  payment  of  bid 
by  holders  under  the  foreclosed  mortgage. 

VI 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  RECEIVERSHIP  OF 

THE  RAILROAD  COMPANY  . 187 

Receivership  generally;  outline  of  management  and  op- 
eration of  road  by  receiver — Grounds  for  a  receivership; 
when  appointed;  default  in  interest  or  principal;  in- 


CONTENTS  xiii 

PAGE 

solvency;  inadequate  security;  when  income  mortgaged; 
threatened  waste  of  property;  application  by  railroad  com- 
pany— Attitude  of  the  courts  toward  receiverships  of  rail- 
roads; serving  the  interests  of  the  public  and  the  holders 
under  the  mortgage — Appointment  is  discretionary  with  the 
court;  consent  of  the  parties  in  interest;  bond  of  the  re- 
ceiver— Effect  of  receivership  on  existing  rights ;  mort- 
gages or  other  liens  how  affected;  attaching  creditors; 
judgment  creditors;  suits  against  the  receiver — Ancillary 
receiverships;  road  running  through  two  or  more  States; 
appointment  of  same  receiver  in  each  jurisdiction;  juris- 
diction of  the  courts  of  each  State;  may  appoint  their  own 
receiver — Receivership  of  parent  road  and  of  branch  or 
subsidiary  lines — Who  is  chosen  as  receiver;  consent  of 
parties  in  interest;  qualifications  of  receiver — Receiver 
represents  the  court;  subject  only  to  its  control — General 
powers  and  duties  of  receiver  while  operating  the  road; 
application  to  the  court  for  instructions  and  authority; 
what  the  court  generally  allows  the  receiver  to  do — Dis- 
cretion of  the  receiver  in  the  management  and  operation 
of  the  road — Effect  of  the  contracts  of  the  insolvent  road 
on  the  receiver;  leased  lines;  leases  of  rolling  stock;  car 
trust  agreements — Expenditures  by  the  receiver — Expendi- 
tures for  large  amounts  or  for  unusual  purposes;  making 
unusual  contracts — Income  during  receivership ;  how  ap- 
plied; anticipating  income — Receiver's  certificates;  only 
when  absolutely  necessary,  unusual  security;  lien  the  court 
gives  them;  several  issues;  when  payable;  rate  of  inter- 
est; selling  price;  obligations  of  the  receiver;  their  form 
and  transfer;  enforcing  their  payment;  reasons  for  dis- 
placino-  Hen  of  holders  of  bonds  and  notes  under  their 
mortgage;  notice  to  such  holders;  entitled  to  be  heard — 
Official  liability  of  the  receiver;  his  personal  liability — 
Liability  of  sureties  on  receiver's  bond — Accounting  by  re- 
ceiver— Removal  of  the  receiver;  his  resignation — Compen- 
sation of  the  receiver;  fixed  by  statute  or  the  court;  for- 
feiting compensation ;  paid  out  of  property  or  by  contribu- 
tion— Termination  of  the  receivership. 

VII 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  ASSETS  OF  THE 
INSOLVENT    RAILROAD    COMPANY;    RIGHTS    AND    PRIORITIES 

OF  THE   OTHER  CREDITORS 227 

General  rules  of  distribution  of  the  assets  of  the  insol- 
vent road;  mortgages  and  other  liens;  secured  and  un- 
secured creditors — Income  earned  by  the  railroad  company 
before  its  default;  after  default;  income  earned  by  the 
receiver — Distribution  of  income  and  proceeds  of  the  mort- 
gaged property  when  trustee  takes  possession,  operates,  or 
sells — Creditors  of  the  railroad  generally;  what  is  meant 


xiv  CONTENTS 

PAGE 

by  priority — Creditors  on  equal  footing — Successive  mort- 
gages or  other  liens;  waiving  priorities — Closed  mort- 
gages; open-end  mortgages;  bonds  in  series;  open  mort- 
gages— Numbered  bonds — Over-issued  bonds  or  notes — 
Re-issued,  exchanged,  and  substituted  bonds  or  notes — 
New  mortgage  before  all  bonds  or  notes  under  prior 
mortgage  are  put  out — Operating  expenses  prior  to  re- 
ceivership; nature  of  claims  entitled  to  this  preference;  six 
months  rule;  extent  of  preference;  reasons  therefor;  funds 
affected  by  the  preference — Claims  for  original  construction 
— Mechanics'  liens — Attachments  and  executions  against 
property  of  the  road — Preferred  stock — Taxes,  public  as- 
sessments, governmental  charges — Purchase  money  mort- 
gages; conditional  sales — Right  of  way  claims — Judgments 
— Claims  and  judgments  for  injuries  to  persons  or  prop- 
erty— Priorities  among  interest  coupons  and  claims  for  in- 
terest; between  principal  and  interest — Notes;  debentures 
or  unsecured  bonds — First  lien  bonds — First  mortgage 
bonds;  first  mortgage  trust  bonds;  first  mortgage  con- 
solidated bonds;  second,  third,  etc.,  mortgage  bonds — Uni- 
fication; general  mortgage  bonds;  blanket  mortgage  bonds 
— Underlying  liens — Refunding  mortgage  bonds — Bonds  re- 
sulting from  consolidation,  merger,  lease  or  control  of 
property  or  stock  of  subsidiary  companies — Collateral 
trust  bonds;  collateral  trust  notes;  convertible  collateral 
trust  bonds  or  notes;  participating  or  profit  sharing  bonds 
or  notes;  three  plans  for  issuing  collateral  trust  bonds — 
Bonds  or  notes  of  consolidated  roads ;  of  the  constituent 
roads ;  Divisional  bonds — Guaranteed  bonds  or  notes — 
Stamped  bonds — Assumed  bonds — Terminal  bonds — Bonds 
relating  to  development;  development  bonds — Extension 
bonds — Bonds  to  construction  company — Car  trust  cer- 
tificates or  bonds — Equipment  trust  certificates  or  bonds — 
Equipment  bonds — Bonds  growing  out  of  the  reorganiza- 
tion or  readjustment  of  the  railroad  company  generally — 
Assented  bonds — Prior  lien  bonds;  preferential  bonds — 
Extended  bonds  or  notes — Scaling — Income  bonds;  deben- 
ture income  bonds;  mortgage  income  bonds;  non-cumula- 
tive income  bonds;  cumulative  income  bonds;  assented  in- 
come bonds. 

VIII 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE  REORGANIZATION 

OF  THE  RAILROAD  COMPANY 335 

Different  forms  of  reorganizations;  new  charter;  sale  or 
lease  of  property;  consolidation  or  merger;  assessment  of 
stockholders ;  bondholders  waiving  lien  and  accepting  new 
securities;  scaling;  new  management — Outline  of  pro- 
cedure in  reorganization — Attitude  of  courts  toward  re- 
organizations; proposed  reorganization  must  be  fair — 


CONTENTS  xv 

PAGE 

Rights  of  bondholders,  generally,  to  participate  in  the 
reorganization ;  to  receive  notice  and  an  opportunity  to 
examine  proposed  agreement  for  reorganization — Rights  of 
bondholders  who  do  not  join  in  the  reorganization;  rights 
upon  withdrawal  from  agreement  or  abandonment  of  re- 
organization; reorganization  of  majority  against  objections 
of  minority;  provisions  in  mortgage  empowering  majority; 
interest  of  minority  protected  by  courts — Bondholders  may 
reorganize  alone ;  or  with  other  creditors  or  with  stock- 
holders, or  both;  interests  of  unsecured  creditors  pro- 
tected; rights  of  stockholders  of  insolvent  company;  terms 
upon  which  they  may  acquire  rights  in  new  company — 
Synopsis  of  reorganization  agreement — Becoming  a  party  to 
the  agreement;  by  signing;  by  deposit  of  securities;  limita- 
tion of  period;  extension  of  period;  penalty — Use  of  de- 
posited bonds;  how  bonds  deposited — Certificate  of  deposit; 
its  transfer;  its.  negotiability;  rights  of  transferor  and 
transferee;  interest  on  bonds  represented  by  certificates  of 
deposit — Synopsis  of  the  plan  for  reorganization — Filing 
the  plan;  giving  notice  thereof;  reasonable  opportunity  to 
examine  it;  proposed  changes;  remedies  when  committee 
fails  to  file  plan  or  give  proper  notice — How  plan  is  for- 
mulated and  submitted;  when  contained  in  agreement;  dis- 
cretion of  committee  to  adopt  plan;  submitting  plan  for  as- 
sent or  dissent;  expressing  assent  or  dissent;  amount  neces- 
sary to  approve  or  reject;  written  assents  or  dissents;  ma- 
jority and  minority  rights  on  approval  or  rejection  of  plan 
— When  plan  takes  effect;  abandoning  plan  after  adoption 
— Changes  in  the  agreement  or  the  plan ;  power  of  com- 
mittee to  make  changes;  uncontrolled  power;  limited  to  cer- 
tain matters;  material  changes;  submitting  changes  to  par- 
ties; unauthorized  changes;  ratification  or  rejection;  rati- 
fication by  majority;  changes  by  majority  against  objection 
of  minority;  provisions  for  majority  control — Powers  of 
committee  defined  by  agreement;  discretionary  powers; 
positive  instructions — Committee  may  employ  representa- 
tives— Committee  may  construe,  remedy,  change,  prepare, 
adopt,  declare  operative,  abandon  plan — Allowing  parties 
to  join  in  the  reorganization;  co-operation  with  other 
committees — Power  of  the  committee  over  deposited  bonds 
— Pursuing  the  remedies  of  the  bondholders — Committee 
may  acquire  property;  its  powers  with  respect  to  same — 
Expenditures  and  debts  by  committee;  expenses;  may  con- 
sent to  receiver's  certificates — Personnel  of  the  committee — 
Individual  interest  of  the  committee — Duties  of  the  com- 
mittee; good  faith;  will  of  the  majority;  accounting;  time 
within  which  to  complete  reorganization;  five  years'  pro- 
vision— Personal  liability  of  the  committee;  money  dam- 
ages; injunction;  compelling  performance  of  duties;  declar- 
ing acts  void;  errors  of  judgment;  limitation  of  liability; 


xvi  CONTENTS 

PAGE 

who  affected  by  limitation;  liability  to  third  persons; 
liability  for  acts  of  co-members;  accounting  and  discharge 
— Purchase  of  property  of  insolvent  road  by  bondholders  or 
committee;  using  bonds  in  payment;  payment  of  costs  in 
cash;  how  bid  paid  when  purchased  by  others;  committee 
using  own  money;  failure  to  complete  purchase;  deficiency 
on  resale — Parties  to  the  agreement  are  bound  by  all 
proper  acts  of  the  committee;  rule  when  committee  acts 
wrongfully;  ratification  of  unauthorized  acts;  remedies  for 
wrongful  acts — Parties  to  the  agreement  are  bound  by  its 
terms;  must  deposit  bonds;  must  pay  share  of  expenses, 
etc, ;  when  such  expenses  are  not  paid ;  parties  avoiding 
liability  under  agreement;  abandonment — Withdrawing 
from  agreement;  surrendering  certificates;  payment  of  ex- 
penses and  charges;  return  of  securities;  limitation  of 
time — Termination  of  the  agreement;  by  completing  reor- 
ganization; committee  may  terminate:  court  may  declare 
agreement  abandoned;  rights  of  parties  when  agreement 
and  proceedings  terminated  by  the  court  or  the  committee — 
Expenses  of  reorganization;  charged  against  deposited  se- 
curities; payment  as  condition  of  right  to  receive  securi- 
ties of  the  new  corporation — The  new  corporation ;  distinct 
legal  body  from  old  corporation;  succeeding  to  franchises; 
name  of  new  corporation ;  distinction  between  franchises  to 
operate  the  road  and  franchise  to  exist  as  a  corporation — 
New  corporation  bound  to  issue  stock,  bonds,  etc.,  accord- 
ing to  plan  or  agreement  for  reorganization;  rights  of  par- 
ties to  securities  of  new  corporation;  when  such  securities 
must  issue;  five  years'  provision;  voting  trust — New  cor- 
poration may  take  property  free  from  all  liens  against  it; 
may  take  same  subject  to  such  liens,  or  some  of  them; 
other  debts  and  contracts  of  the  old  corporation — New  cor- 
poration not  liable  for  contracts  or  debts  of  the  receiver; 
.  exceptions. 


HOLDERS  OF  RAILROAD  BONDS 

AND  NOTES :  THEIR  RIGHTS 

AND  REMEDIES 

CHAPTER  I 

INTRODUCTORY 

Three  values  of  a  railroad  security. 

Generally  speaking,  a  railroad  security  may  be 
said  to  have  three  values.  It  has  a  market  value, 
the  price  at  which  it  can  be  bought  and  sold  (prob- 
ably) in  the  market.  It  has  an  intrinsic  value,  de- 
pending upon  the  solvency  of  the  issuing  company 
and  the  property  or  security  behind  it.  It  has  a  legal 
value,  founded  upon  the  rights  and  remedies  its  own- 
ership confers  to  enforce  its  payment  and  which  en- 
titles it  by  reason  of  its  legal  lien  or  standing  to  be 
paid  out  of  certain  property  of  the  road  or  out  of  all 
its  property,  as  the  case  may  be,  before  other  credi- 
tors or  other  classes  of  creditors  receive  anything. 

Market  value. 

The  market  value  of  a  railroad  security  does  not 
depend  always  upon  its  actual,  intrinsic  value  alone, 


2  RAILROAD  BONDS  AND  NOTES 

i.  e.,  upon  the  property  and  its  foreclosure  value, 
pledged  as  security,  and  the  other  liens,  prior  and 
junior,  against  such  property;  but  it  is  affected,  quite 
often,  and  sometimes  quite  materially,  by  extraneous 
influences,  among  them  the  temper  of  the  times;  the 
state  of  the  money  market;  the  quoted  price;  whether 
or  not  it  has  a  broad  and  ready  market  and  is  a  legal 
investment  for  trust  funds  or  savings  banks ;  its  form, 
whether  easy  of  negotiation  and  how  quickly  it  can 
be  converted  into  cash;  when  it  matures;  its  rate  of 
interest  and  the  income  it  produces  at  the  price; 
whether  or  not  it  is  listed  on  the  stock  exchanges ;  the 
personnel  of  the  board  of  directors  of  the  railroad 
company;  the  prevalent  reports,  true  or  false,  of  the 
state  of  the  finances  and  affairs  of  the  road ;  the  effect 
of  recent  legislation  or  expected  legislation;  recent 
decisions  of  the  higher  courts;  pending  litigation  that 
affects  the  road;  events  and  reports  of  political  sig- 
nificance, local,  state,  national  or  international. 

Intrinsic  value. 

To  determine  the  intrinsic  value  of  a  railroad  se- 
curity, inquiry  is  directed  by  experts  to  the  credit  and 
standing  of  the  issuing  company;  the  condition  of 
its  finances ;  the  nature  of  its  franchises ;  the  property 
mortgaged  as  security  and  its  physical  condition; 
what  the  prior  and  later  liens  against  this  property 
are;  the  company's  entire  property  generally;  the 
contracts  and  leases  by  which  the  road  is  bound  or  has 


INTRODUCTORY  3 

the  advantage  of;  what  the  entire  outstanding  bonded 
indebtedness  of  the  company  is  and  how  it  is  secured ; 
whether  the  bonded  indebtedness  of  the  issuing  com- 
pany is  in  excess  of  the  actual  or  foreclosure  value  of 
the  road  as  near  as  it  can  be  judged;  whether  the 
proportion  of  the  bonded  indebtedness  to  the  capital 
stock  of  the  road  is  proper;  the  topography  of  the 
country  over  which  the  road  is  laid ;  the  geographical 
position  of  the  road  and  whether  it  commands  a 
strategic  position;  whether  it  serves  a  needed  pur- 
pose; its  future  prospects;  whether  the  territory  and 
termini  served  can  be  reasonably  expected  to  main- 
tain the  road;  whether  the  population  in  the  territory 
and  points  served  is  increasing  or  decreasing;  the 
character  of  the  traffic,  whether  it  is  limited  to  cer- 
tain industries  or  is  general  and  diversified;  what 
rival  lines  are  in  competition;  whether  the  road  is 
likely  to  be  absorbed  by  a  larger  one  and  the  possi- 
bility of  its  securities  being  made  valueless  upon  the 
market  before  the  absorption;  the  personal  character 
and  efficiency  of  the  company's  management ;  its  poli- 
cies; its  aggressiveness  or  conservativeness ;  whether 
or  not  the  business  of  the  road  is  being  conducted 
along  conservative  lines;  whether  or  not  those  in  con- 
trol have  other  interests  that  conflict  with  the  best 
interests  of  the  company ;  the  amount  of  business  the 
road  is  doing;  its  permanent  earning  power;  the  pro- 
portion that  the  capitalization  of  the  road  per  mile 
bears  to  the  earning  capacity  per  mile;  whether  the 


4  RAILROAD  BONDS  AND  NOTES 

gross  earnings  have  been  maintained  from  year  to 
year;  whether  the  ratio  of  the  operating  expenses  per 
mile  is  reasonably  proportioned  to  the  gross  earnings 
per  mile  and  that  this  proportion  has  been  maintained 
from  year  to  year;  that  the  fixed  charges  are  for 
proper  purposes  and  are  kept  to  the  minimum  and  are 
not  out  of  proportion  to  the  gross  earnings;  and  in 
addition  such  other  matters  as  the  particular  issue 
under  consideration  calls  for. 

The  average  investor  has  neither  the  opportunity 
to  get  at  these  facts  nor  the  experience  in  the  various 
branches  of  expert  knowledge  necessary  to  under- 
stand or  judge  them.  These  matters  should  be  and 
are  examined  into  by  financial  and  engineering  ex- 
perts upon  whose  opinion  the  bankers  depend  when 
underwriting  or  purchasing  an  issue,  and  it  is  upon 
the  recommendations  of  the  latter  as  to  the  intrinsic 
value  of  the  security  that  the  intending  investor  usu- 
ally and  necessarily  relies. 

Legal  value. 

The  legal  value  of  a  railroad  security  is  the  foun- 
dation of  both  its  market  and  intrinsic  values.  For 
its  legal  rank  as  a  security,  its  rights  to  priority  in 
payment  over  the  other  indebtednesses  of  the  com- 
pany, its  form  and  negotiability,  and  such  special 
rights  and  privileges  that  may  be  peculiar  to  that 
issue,  affect  its  market  value  and  enter  materially 
into  a  consideration  of  its  intrinsic  value. 


INTRODUCTORY  5 

While  the  railroad  company  is  paying  interest 
regularly  and  there  is  no  apparent  reason  for  concern, 
the  legal  rights  and  remedies  that  the  security  may 
carry  with  it  are  not  given  much  thought.  Then  the 
price  at  which  it  may  be  bought  or  sold  and  the  ready 
market  that  it  may  have  are  alone  considered.  But 
when  the  railroad  company  falls  into  insolvency  then 
the  safety  of  the  security  is  thought  of.  And  in  the 
usual  struggle  among  its  creditors  over  its  assets, 
those  rights  that  enable  the  holders  of  its  securities 
to  obtain  payment  in  full  in  preference  to  or  priority 
over  other  creditors  or  other  classes  of  creditors  be- 
come of  prime  importance.  It  is  this  that  constitutes 
the  legal  value  of  a  railroad  security  and  upon  which 
its  market  and  intrinsic  values  depend. 

In  adjusting  the  affairs  of  an  insolvent  railroad 
corporation,  the  court  usually  finds  itself  confronted 
with  claims  of  many  kinds  and  with  many  classes  of 
creditors.  In  the  unraveling  of  the  entangled  mesh 
each  strand  must  be  given  its  position. 

Usually  it  will  be  found  that  the  insolvent  road  is 
a  system  consisting  of  a  number  of  branch  lines 
operated  under  leases  or  by  subsidiary  companies. 
These  subsidiary  companies  are  invariably  controlled 
by  the  main  or  parent  company  by  means  of  a  con- 
trolling interest  in  their  capital  stocks  or  by  owner- 
ship of  their  properties.  The  financing  of  these  ex- 
tensions, branch,  subsidiary,  divisional  and  leased 
lines,  and  of  the  main  or  parent  road,  results  in  many 


6  RAILROAD  BONDS  AND  NOTES 

issues  of  notes  and  bonds  and  other  forms  and  kinds 
of  securities.  And  it  is  not  unusual  that  the  insol- 
vency of  a  railroad  will  find  creditors  holding  bonds 
secured  by  underlying  liens  against  all  or  certain  por- 
tions of  the  property  of  the  road  issued  by  constituent 
companies  before  consolidation  or  representing  the 
original  mortgages  upon  the  road,  followed  by  first, 
second,  general,  blanket  or  unified  mortgages  on  the 
entire  system;  collateral  trust  bonds  issued  by  the 
parent  company  and  secured  by  a  deposit  of  the 
stocks  and  bonds  from  its  own  treasury  or  the  securi- 
ties of  its  subsidiary  companies;  also  bonds  resulting 
from  an  attempt  at  readjustment  or  reorganization, 
such  as  extended  bonds,  prior  lien  bonds,  adjustment 
bonds,  income  bonds,  etc.;  outstanding  notes  or 
debentures  that  are  not  secured;  car  trust  certificates 
or  equipment  bonds  may  cover  the  rolling  stock  and 
equipment  of  the  road;  terminals  may  have  been 
mortgaged  to  secure  an  issue  of  bonds  or  notes ;  some 
of  the  creditors  may  have  outstanding  attachments 
against  the  road,  or  may  have  reduced  their  claims 
to  judgments;  interest  on  preferred  stock  may  have 
been  made  a  lien  on  the  property  of  the  road  or 
some  parts  of  it;  certain  claims  for  labor  and  ma- 
terials may  be  entitled  to  preference  as  operating  ex- 
penses or  under  statutes;  claims  for  injuries  to  per- 
sons or  property  caused  in  the  operation  of  the  road 
before  the  receivership  may  be  given  a  preference  by 
the  statutes  of  some  of  the  States;  mechanics'  liens 


INTRODUCTORY  7 

may  be  charged  against  the  property  of  the  road 
And,  further,  should  a  receiver  be  appointed  he  may, 
under  order  of  the  court,  issue  receiver's  certificates, 
which  may  be  given  a  lien  prior  to  and  a  preference 
over  mortgages  and  other  liens  then  against  the  prop- 
erty of  the  road.  Also  the  claims  for  the  expenses 
of  the  receivership  and  of  the  operation  of  the  road 
by  him,  and  the  expenses  of  the  trusteeship,  and  the 
costs  and  expenses  of  the  litigation  are  given  a  pri- 
ority in  payment  over  all  the  preceding  claims.  And 
the  debts  for  taxes  and  other  governmental  charges 
are  usually  entitled  to  a  preference  over  all  others. 

The  relative  rights  and  standings  of  these  different 
securities  and  claims,  their  priorities  and  preferences, 
and  the  order  in  which  each  shares  in  the  assets  of 
the  railroad  company,  constitute  their  legal  values, 
and  it  is  the  purpose  of  these  pages  to  discuss  and  to 
analyze  each  security  or  claim  against  the  road  that 
will  in  any  way  affect  the  rights  or  the  remedies  of 
the  holders  of  the  outstanding  bonds  and  notes,  and 
show  the  reason  for  the  standing,  priority  or  pref- 
erence accorded  it. 


CHAPTER  II 

RIGHTS    AND    REMEDIES    WITH    RELATION    TO    THE 
VARIOUS    KINDS    OF    RAILROAD    BONDS    AND    NOTES 

General  description  of  railroad  bonds,  notes,  and 
debentures;  bonds  and  notes  compared; 
power  of  railroad  company  to  issue  same; 
temporary  bonds. 

A  bond  of  a  railroad  company  may  be  described, 
generally,  as  its  written  obligation  to  pay  a  certain 
sum  of  money,  on  a  specific  date,  with  interest  at  a 
fixed  rate,  the  interest  payable  at  stated  periods. 

Speaking  broadly,  a  railroad  bond  resembles,  in 
its  nature,  the  usual  promissory  note.  The  bond  is 
more  elaborate  in  form,  and  more  formal  in  its  exe- 
cution; and  usually  in  addition  to  the  elements  that 
make  up  a  promissory  note,  the  bond  contains  terms 
that  confer  on  its  holder,  or  registered  owner,  certain 
special  rights  and  remedies,  and  reserve  in  the  rail- 
road company  making  the  issue  certain  special 
privileges.  What  these  special  rights,  remedies,  and 
privileges  are  depend  upon  the  kind  of  bond  in 
question,  to  which  discussion  will  be  directed  later. 

A  railroad  company,  when  it  is  necessary  for 
proper  corporate  purposes,  may  borrow  money  and 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     9 

issue  bonds  as  evidences  of  such  indebtedness  and  of 
its  promise  to  pay. 

It  is  quite  commonly  the  law  in  most  of  the  States 
that  before  a  railroad  company  may  issue  its  bonds 
or  stocks,  it  must  first  obtain  from  the  public  service 
commission  having  control  of  the  jurisdiction  to 
which  the  railroad  company  is  subject,  an  order 
authorizing  such  issue  and  the  amount  thereof  and 
stating  that,  in  the  opinion  of  such  commission,  the 
use  of  the  capital  to  be  secured  by  the  issue  of  such 
stock  or  bonds  is  reasonably  required  for  the  cor- 
porate purposes  of  the  railroad  company. 

When  a  railroad  company  issues  and  sells  its 
bonds,  it  is  in  effect  selling  its  written  promise  to 
pay  the  money  it  then  borrows.  Each  issue  is  a 
promise  to  pay  the  entire  amount  authorized;  and 
each  bond  of  that  issue  represents  that  entire  prom- 
ise divided  into  as  many  parts  as  there  are  bonds. 

A  railroad  company  has  power  to  issue  bonds  for 
any  purpose  for  which  it  might  lawfully  contract  a 
debt.  This  power  to  issue  bonds  is  regarded  as  inci- 
dental to  the  inherent  powers  of  the  corporation  and 
need  not  be  expressly  conferred  on  it  by  its  charter 
or  any  statute.  But  the  exercise  of  this  power  to 
issue  bonds  may  be  limited,  restricted  or  regulated  by 
some  provision  in  the  charter  of  the  corporation,  or  a 
statute,  or  the  constitution  of  the  State  in  which  the 
railroad  company  is  incorporated.  Bonds  issued  in 
violation  of  these  limitations,  restrictions  or  regula- 


10 

tions  are,  as  a  rule,  void.  Fairly  typical  of  such 
provisions  is  that  which  declares  that  the  aggregate 
amount  for  which  a  railroad  company  may  issue  and 
have  bonds  outstanding,  shall  not  exceed  a  specified 
proportion  of  its  capital  stock  or  property. 

Unless  restrained  by  law,  a  railroad  company  may 
use  any  form  of  security  that  any  other  corporation 
or  individual  might  under  the  same  circumstances. 

Railroad  bonds  are  usually  made  payable  at  far 
distant  dates,  so  that  the  money  raised  by  them  and 
employed  in  the  building,  equipping  and  improving 
of  railroads  may  have  a  full  opportunity  to  bring 
forth  its  fruit.  When  the  rate  of  interest  and  the 
market  conditions  are  favorable,  the  bonds  are  for 
long  terms ;  and,  conversely,  when  the  rate  of  interest 
is  high  and  the  market  is  unfavorable,  the  issuing 
company  will  put  out  notes  for  a  short  term,  and 
when  conditions  become  more  satisfactory,  long  term 
bonds  are  issued  and  the  short  term  notes  are  taken 
up. 

An  issue  of  railroad  notes,  like  an  issue  of  railroad 
bonds,  is  the  written  promise  to  pay  a  certain  sum 
of  money  at  a  specified  date,  with  a  fixed  rate  of  in- 
terest. Railroad  notes  differ  from  railroad  bonds 
only,  usually,  in  the  particular  pointed  out,  that  they 
are  for  shorter  periods.  Railroad  notes  may  be 
issued  in  coupon  form,  as  bonds  may  be,  and  have 
coupons  attached  to  represent  the  interest. 

Railroad  notes  are  sometimes  secured  by  a  mort- 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     11 

gage  on  the  property  of  the  road,  or  by  a  deposit  of 
collateral  securities,  or  in  any  other  way  that  rail- 
road bonds  are  secured. 

The  same  rules  of  law  apply  to  notes  as  apply  to 
bonds  and  the  same  situation  is  presented  when 
notes  are  issued  or  secured  as  when  bonds  are.  And 
throughout  these  pages  where  reference  is  made  to 
bondholders  it  is  intended  to  have  reference  to  note- 
holders also,  where  the  issue  is  of  notes  and  where 
the  circumstances  are  alike  except  that  the  instrument 
is  a  note  instead  of  a  bond. 

When  a  railroad  bond  is  not  secured,  it  is  quite 
generally  known  as  a  "debenture."  To  prevent  the 
railroad  company,  by  subsequently  mortgaging  its 
property,  from  practically  disposing  of  its  assets,  it 
is  usually  provided  in  the  agreement  pursuant  to 
which  the  debentures  are  issued  that  the  railroad 
company  shall  not  place  any  mortgage  upon  its 
property;  in  this  way  while  the  debentures  are  not 
secured,  they  are  protected  in  that  the  equity  in  the 
property  as  it  existed  at  the  time  of  the  issue  and  to 
which  they  looked  for  payment  will  not  be  taken 
from  them  by  mortgages  to  secure  later  issues  of 
bonds  or  other  forms  of  indebtedness.  Or  provision 
may  be  made  to  the  effect  that  should  the  railroad 
company  place  any  later  mortgage  upon  its  property 
that  such  debentures  shall  be  included  in  such  later 
mortgage  and  be  secured  by  it.1 

term  "debenture"  is  used  in  the  English  speaking  nations 


12  RAILROAD  BONDS  AND  NOTES 

Until  the  bonds  can  be  engraved,  the  railroad 
company  usually  executes  and  delivers  temporary 
bonds,  which  are  either  printed  or  lithographed,  and 
are  substantially  of  the  tenor  of  the  engraved  or  per- 
manent bonds.  Each  temporary  bond  bears  upon 
its  face  the  statement  that  it  is  a  temporary  bond  and 
is  exchangeable  for  a  like  principal  amount  of  en- 
graved bonds.  Temporary  bonds  must  be  authenti- 
cated by  the  trustee's  certificate  in  the  same  manner 
as  the  permanent  or  engraved  bonds.  When  the 
temporary  bond  is  exchanged  for  the  engraved  bond, 
it  is  cancelled  by  the  trustee ;  and  until  so  exchanged, 
the  temporary  bond  confers  on  its  holder  all  the 
rights  that  the  engraved  bond  does. 

to  designate  instruments  widely  different  in  their  characteristics. 
In  the  financial  circles  of  the  United  States,  it  is  used  to  convey 
the  idea  of  an  unsecured  bond.  It  is  also  applied  here  to  cer- 
tificates given  by  the  collector  of  the  ports  of  entry  for  moneys 
due  by  the  United  States  Government  to  importers  for  drawback 
of  duties  on  merchandise.  In  some  of  the  governmental  depart- 
ments, the  term  is  employed  to  designate  bonds  or  bills  by  which 
the  government  is  charged  to  pay  money  due  on  the  auditing  of 
accounts. 

The  term  "debenture"  is  used  throughout  Great  Britain  and 
her  colonies  to  designate  the  bond  obligations  of  municipalities. 

In  England  the  term  is  used  to  designate  the  bonds  of  munici- 
pal and  other  corporations;  and  it  also  is  the  name  applied  to 
custom  house,  exchequer,  and  other  governmental  obligations.  It 
is  chiefly  employed  there  to  designate  an  instrument  issued  by  a 
corporation  which  creates  or  acknowledges  a  debt  and  usually, 
though  not  necessarily,  charges  the  property  and  undertaking  of 
the  issuing  company. 

In  Canada  while  the  obligations  of  municipalities  are  also  re- 
ferred to  as  debentures,  they  are  more  particularly  designated 
"municipal  debentures."  It  seems  to  be  the  custom  there  to  refer 
to  bonds  of  municipalities  as  "municipal  debentures"  and  the  bonds 
of  other  corporations  as  "bonds." 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      13 

It  is  invariably  provided  in  railroad  mortgages 
that  the  bonds  under  it  shall  be  signed  by  such  per- 
sons as  shall,  at  the  time  of  such  signing,  be  the  presi- 
dent or  the  vice-president  of  the  issuing  company, 
and  that  the  corporate  seal  of  the  company  shall  be 
affixed  and  that  it  shall  be  attested  by  such  person  as 
shall,  at  such  time,  be  the  secretary  or  an  assistant 
secretary;  and  that  the  coupons  shall  be  authenti- 
cated by  the  engraved  signature  of  the  present  treas- 
urer, or  of  any  future  treasurer,  of  the  issuing  com- 
pany. And,  it  is  invariably  further  provided  that, 
should  any  of  such  bonds  have  been  signed  and 
sealed  by  the  officers  of  the  issuing  railroad  company, 
and  thereafter  such  persons  shall  cease  to  be  such 
officers,  such  bonds  may  be  delivered  to  the  trustee 
to  be  certified  to  and  put  out  by  him,  or  returned  to 
the  railroad  company  to  be  put  out  by  it,  as  the  case 
may  be,  with  the  same  effect  as  if  such  persons  had 
not  ceased  to  be  such  officers  of  the  issuing  railroad 
company. 

Transfer  of  bonds. 

The  bond  may  be  payable  to  bearer  or  to  the 
order  of  a  designated  payee. 

When  payable  to  bearer,  the  bond  is  transferred 
by  its  delivery  from  hand  to  hand,  without  any 
writing.  When  payable  to  the  order  of  a  designated 
payee,  the  bond  must  be  transferred  in  writing. 

When  the  bond  is  issued  with  the  space  reserved 


14  RAILROAD  BONDS  AND  NOTES 

for  the  name  of  the  payee  left  blank,  any  holder  has 
the  legal  right  to  fill  in  his  own  name  as  payee. 
While  the  holder  has  the  legal  right  to  do  this,  the 
filling  in  of  his  name  as  payee  in  the  blank  space 
may  affect  its  commercial  value.  It  is  then  a 
"marked  bond,"  the  expression  used  in  financial  cir- 
cles, and  no  longer  accepted  as  a  "good  delivery." 

With  the  space  for  the  name  of  the  payee  left 
blank,  the  bond  is  regarded  as  payable  to  bearer  and 
transferred  by  its  mere  manual  delivery;  when  the 
name  of  the  holder  has  been  filled  in  the  space  re- 
served, the  bond  becomes  payable  to  his  order  and  is 
then  transferable  only  by  his  written  assignment. 

A  registered  bond  is  one  that  bears  the  name  of 
its  payee  on  its  face,  and  is  registered  in  the  name  of 
such  payee  on  the  books  of  the  railroad  company,  or 
the  fiscal  agency  designated  for  that  purpose.  It  is 
transferred  by  written  assignment  or  power,  in  a 
form  approved  by  the  railroad  company.  Some 
bonds  have  the  form  printed  on  their  backs.  The 
bond  and  assignment  are  delivered  to  the  new  owner, 
who  then  presents  them  to  the  railroad  company  or 
the  fiscal  agency,  as  the  case  may  be,  and  the  name  of 
such  new  owner  is  then  registered  on  the  books  of  the 
company  and  a  notation  made  on  the  bond  signifying 
its  registration,  or  a  new  bond  may  be  issued  with  the 
name  of  the  new  owner  on  its  face  as  payee.  See 
Registered  bonds;  act  of  registration,  etc.  Page  48. 
See  also  Transfer  of  registered  bonds,  etc,  Page  50, 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      15 

Difference  between  bondholders  and  stockholders. 

As  the  bond  is  the  written  promise  of  the  railroad 
company  to  pay  to  the  one  entitled  thereto,  accord- 
ing to  its  terms,  the  holder  of  such  bond  is  a  creditor 
of  the  issuing  railroad  company. 

The  bondholders  are  creditors  of  the  railroad  com- 
pany; the  stockholders  are  members  of  the  company 
that  owes  the  money  to  the  bondholders.  The  bond- 
holders are  entitled  to  demand  payment  of  their 
bonds  and  interest  of  the  railroad  company;  the 
stockholders  are  members  of  the  company  that  must 
pay  the  bondholders. 

When  the  assets  of  a  railroad  company  are  finally 
distributed  upon  a  winding  up  of  its  affairs,  the  bond- 
holders and  the  other  creditors  are  first  paid  in  full, 
according  to  their  respective  priorities,  before  the 
stockholders  receive  anything.  Stockholders  are  en- 
titled to  their  shares  of  the  assets  of  the  corporation 
only  after  all  the  creditors,  of  every  kind,  have  been 
paid  in  full. 

Bondholders,  like  other  creditors,  ordinarily,  do 
not  have  the  power  to  vote  at  any  of  the  corporate 
meetings.  Stockholders  do  have  this  right.  In 
some  instances,  though  rarely,  the  power  to  vote  is 
given  to  bondholders,  either  by  the  terms  of  the  mort- 
gage or  by  the  statute  laws  of  the  State. 

The  bondholders  receive  a  fixed  rate  of  interest  on 
their  bonds,  which  is  a  fixed  charge  or  expense  of  the 
railroad  company;  the  stockholders  (of  common 


16  RAILROAD  BONDS  AND  NOTES 

stock)  receive  dividends  on  their  stock  dependent 
upon  the  condition  of  affairs  of  the  company  and  as 
the  board  of  directors  shall  declare  them.  The 
holder  of  the  preferred  stock  is  paid  his  stipulated 
rate  of  dividend  only  after  the  interest  on  the  bonded 
indebtedness  and  all  the  annual  fixed  charges  are 
paid.  He  is  in  the  same  position  with  relation  to 
the  bondholder  as  is  the  holder  of  the  common  stock, 
though  his  dividend  is  payable  before  that  of  the 
latter  and  sometimes  his  interest  in  the  assets  of 
the  corporation  has  priority  over  that  of  the  holder 
of  common  stock. 

Bondholders  are  bound  by  the  terms  of  the  bond 
and  mortgage;  the  contract  between  the  par- 
ties. 

The  bondholder  is  bound  by  all  the  terms  and  pro- 
visions and  conditions  contained  in  his  bond.  He  is 
chargeable  with  notice  of  all  the  facts  that  appear 
on  its  face  or  are  endorsed  on  it.  He  is  chargeable 
also  with  notice  of  all  the  terms,  conditions,  and 
provisions  contained  in  the  mortgage  when  the  bond 
refers  to  the  mortgage  with  sufficient  directness  to 
apprise  him  of  its  existence.  The  provisions  of  the 
mortgage,  by  such  reference,  become  part  of  the 
bond  with  the  same  effect  as  if  there  set  forth  at 
length. 

The  bond  and  the  mortgage  constitute  the  contract 
between  the  bondholder,  the  railroad  company,  and 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      17 

the  trustee.  And  like  all  contracts  its  provisions  are 
binding  on  all  the  parties  to  it.  It  is  in  the  con- 
struction that  the  courts  put  on  the  language  used  in 
these  two  documents,  that  the  rights  and  remedies 
of  the  bondholders  are  to  be  found.  The  courts,  in 
construing  the  language  of  the  bond  and  the  mort- 
gage, are  controlled  by  statute  laws,  the  general 
precedents,  and  by  the  principles  that  apply  partic- 
ularly to  railroad  property  and  which  govern  the 
peculiar  relations  that  exist  between  the  bondholders 
and  the  trustee  and  the  railroad  company;  all  of 
which  is  read  into  and  form  part  of  the  bond  and 
mortgage.  These  statute  laws,  general  precedents, 
and  particular  principles  will  be  presented  and  dis- 
cussed, throughout  these  pages,  under  the  appropri- 
ate headings. 

The  legal  residence  of  a  railroad  company  is  the 
State  under  the  laws  of  which  it  is  created ;  and  it  is 
the  law  of  that  State  that  governs  the  construction  of 
the  contract  of  the  parties. 

Each  bondholder  is  bound  by  the  terms  of  this 
contract;  and  each  is  entitled  to  its  protection.  And 
neither  the  trustee,  nor  any  reorganization  com- 
mittee, nor  any  majority  of  the  bondholders,  can  de- 
prive him  of  any  of  his  rights  by  making  any  change 
in  the  terms  of  the  bond  or  the  mortgage,  or  by 
waiving  any  default  by  the  railroad  company  under 
them,  unless  the  bondholder  has  agreed  and  con- 
sented that  they  have  such  power.  This  power  to 


18  RAILROAD  BONDS  AND  NOTES 

bind  all  the  bondholders  of  an  issue  by  the  acts  of  a 
majority  or  of  the  trustee,  may  be  conferred  by  the 
terms  of  the  mortgage,  or  by  the  statute  law  of  the 
State  which,  as  was  seen,  forms  part  of  the  bond  and 
the  mortgage. 

In  case  of  a  conflict  between  the  terms  of  the  bond 
and  the  mortgage,  those  of  the  bond  will  prevail ;  for 
the  bond  is  the  written  evidence  of  the  indebtedness, 
while  the  mortgage  is  the  instrument  merely  that  in- 
sures the  payment  of  such  indebtedness.  The  bond 
is  the  basic  document:  the  mortgage  depends  on  the 
bond  for  existence.  There  may  be  a  bond  without 
a  mortgage;  there  cannot  be  a  mortgage  without  a 
bond. 

Validity  of  bonds;  over-issue;  defective  issue; 
issue  in  excess  or  abuse  of  power;  issue  in 
violation  of  law,  or  without  power;  secured 
by  void  mortgage. 

Bonds  issued  by  a  railroad  company  in  violation 
of  its  charter,  or  the  constitution  of  the  State,  or 
some  of  its  statute  laws,  or  issued  without  any  power, 
are  void. 

Railroad  bonds  that  are  valid  in  the  State  in  which 
the  railroad  company  that  issued  them  is  incorpor- 
ated, are  valid  everywhere.  Where  a  road  runs 
through  two  or  more  States,  it  must  be  incorporated 
under  the  laws  of  each.  And  should  the  bonds  be 
valid  under  the  laws  of  any  of  these  States  they  are 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      19 

valid  everywhere,  even  though  they  might  have  been 
invalid  if  issued  under  the  laws  of  one  or  more  of 
the  other  States  in  which  the  road  is  incorporated. 

Bonds  that  are  part  of  an  over-issue  or  which  have 
been  defectively  issued  or  which  have  been  issued  in 
excess  or  abuse  of  power  where  some  power  existed, 
are  good  in  the  hands  of  a  bona  fide  holder,  who  has 
paid  their  reasonable  value  for  them,  purchased  them 
in  good  faith  before  maturity,  in  the  regular  course 
of  business,  and  without  knowledge  or  notice  of  any- 
thing wrong.  Should  the  holder  of  such  bonds  not 
meet  all  the  requirements  of  bona  fide  holdership, 
as  just  detailed,  then  such  bonds  are  void  in  his 
hands.  Over-issued  or  defectively  issued  bonds,  or 
bonds  issued  in  excess  or  in  abuse  of  power  where 
the  railroad  company  had  some  power  to  make  the 
issue,  are  good  only  in  the  hands  of  a  bona  fide 
holder. 

But  a  distinction  is  drawn  between  bonds  that  are 
over-issued,  or  issued  defectively,  or  in  excess  or  in 
abuse  of  a  power  that  it  possessed,  and  those  issued  in 
violation  of  law  or  without  any  power  at  all  to  do  so. 

Bonds  issued  in  violation  of  law  or  without  any 
power  are  void  in  the  hands  of  all  holders,  includ- 
ing bona  fide  holders.  There  is,  in  these  latter  cases, 
no  mere  error  or  abuse  of  power  that  the  law  will 
seek  to  cure  when  such  bonds  have  come  into  the 
hands  of  innocent  bona  fide  holders;  but  here  is  a 
violation  of  the  law  that  the  court  cannot  condone, 


20  RAILROAD  BONDS  AND  NOTES 

and  an  absolute  absence  of  power  that  the  court  can- 
not supply.  However,  where  the  railroad  company 
has  issued  bonds  without  any  power  to  do  so,  and 
it  has  actually  received  the  money  for  them,  the  law 
will  not  permit  it  to  benefit  by  its  own  wrong,  and 
will  then  enforce  payment  of  such  bonds  when  held 
by  bona  fide  holders.  That  is,  notwithstanding  that 
the  railroad  company  had  no  power  to  issue  the  bonds 
in  question,  if  it  actually  did,  and  received  the  money 
therefor,  and  they  pass  into  the  possession  of  holders 
who  bought  such  bonds  in  good  faith,  before  ma- 
turity in  the  regular  course  of  business,  and  paid 
for  them  their  reasonable  value,  and  without  knowl- 
edge or  notice  that  anything  was  wrong,  then  the 
company  must  pay  such  bonds  to  holders  answering 
all  these  requirements. 

Bonds  otherwise  good  are  not  affected  by  the  fact 
that  they  are  secured  by  a  mortgage  that  is  void  or 
defective.  Should  the  mortgage  be  void,  for  any 
reason,  the  security  only  fails  and  the  bonds  continue 
as  theretofore.  The  bonds  are  good ;  the  attempt  to 
secure  them  has  failed. 

Many  kinds  of  railroad  bonds;  classified  generally 
as  to  form,  security,  purpose  of  issue,  and 
mode  of  retirement,  satisfaction,  or  exchange ; 
distinctions  pointed  out. 

There  are  many  kinds  of  railroad  bonds.  The 
mortgages,  too,  that  secure  them  vary  in  their  terms. 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      21 

It  is  doubtful  if  any  two  issues  are  exactly  alike. 
However,  they  fall  quite  generally  into  classes  that 
are  basicly  similar,  differing  only  with  respect  to 
some  special  agreement  or  stipulation. 

The  names  used  to  designate  issues  of  railroad 
bonds  suggest,  in  a  general  way,  these  special  agree- 
ments or  stipulations  that  characterize  an  issue. 

In  attempting  to  classify  railroad  bonds,  they  may 
be  divided  into  those  relating  to  their  form,  such  as 
coupon  bonds,  registered  bonds,  with  the  privilege 
of  converting  or  interchanging  them;  those  relating 
to  their  security,  such  as  mortgage  bonds  of  the  vari- 
ous ranks,  as  first,  second,  etc.,  general  or  blanket, 
prior  lien,  consolidated,  terminal,  income,  collateral 
trust,  and  those,  too,  that  are  not  secured  such  as, 
generally,  notes  and  debentures;  those  relating  to  the 
purpose  for  which  they  were  issued,  as  refunding, 
improvement,  development,  construction,  etc.,  and 
those  relating  to  the  mode  of  satisfaction,  retirement, 
or  exchange,  such  as  redeemable,  callable,  refunding, 
those  with  the  privilege  of  converting  into  the  capi- 
tal stock  of  the  issuing  company,  those  calling  for 
payment  in  gold,  those  with  arrangement  for  sinking 
fund  or  serial  payment. 

Most  railroad  bonds  contain  one  or  more,  if  not 
all,  of  these  features  that  are  not  inconsistent,  such 
as  a  first  mortgage  (the  security),  refunding  (the 
purpose),  gold  (the  mode  of  payment),  convertible 
coupon  (the  form)  bonds. 


22  RAILROAD  BONDS  AND  NOTES 

The  rights  and  remedies  of  a  holder  of  a  bond  con- 
taining one  or  more  of  the  different  features  dis- 
cussed (form,  security,  purpose  of  issue,  and  mode 
of  satisfaction,  payment  or  retirement),  are  a  com- 
bination of  all  the  rights  and  remedies  that  each 
confers.1 

If  these  names  are  accurately  used,  they  will  give 
in  a  general  way  an  idea  of  the  standing  and  of  the 
nature  of  the  security;  but  one  should  not  depend  on 
the  name  alone,  as  without  any  intention  to  deceive, 
the  name  "first  mortgage,"  for  instance,  may  be  used, 
which,  while  giving  the  intending  bondholder  the  im- 
pression that  it  is  entirely  a  "first"  mortgage,  may  be  a 
first  mortgage  only  upon  a  small  portion  of  the  prop- 
erty pledged  as  security,  and  an  inferior  lien  upon  the 
balance.  Again,  the  term  "first"  may  be  used  to  des- 
ignate it  as  the  first  of  its  kind  that  has  been  issued, 
without  regard  to  the  nature  of  the  security,  such  as 
"first  consolidated"  mortgage  bonds,  which  may  be 
secured  by  a  first  mortgage  upon  the  entire  mortgaged 
property,  so  far  as  the  consolidated  company  that  is- 
sued that  mortgage  is  concerned,  but  which  is  a  mort- 
gage subject,  secondary,  junior  and  inferior,  to  all  the 
mortgages  and  other  liens  that  attached  to  the  prop- 
erty before  the  consolidation  took  place.  See  Bonds 

1  The  right  to  priority  in  payment  in  the  distribution  of  the 
assets  of  the  insolvent  road  under  each  of  the  many  forms  and 
kinds  of  railroad  securities  are  discussed  in  Chapter  VII.  Rights 
and  Remedies  iuith  Relation  to  the  Assets  of  the  Insolvent  Rail- 
road Company;  Rights  of  the  Other  Creditors. 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     23 

or  notes  of  consolidated  roads;  of  the  constituent 
roads.     Page  286.     Underlying  liens.     Page  271. 

Rights  of  bona  fide  holders  of  negotiable  bonds. 

In  the  broad  sense  of  the  term,  and  as  commer- 
cially understood,  a  railroad  bond  is  negotiable  when 
it  is  in  such  form  that  it  may  be  transferred  from 
hand  to  hand  by  delivery  or  assignment  in  blank. 
But  a  bond  may  be  negotiable  in  that  respect  and 
may  not  be  negotiable  in  the  strict  legal  sense  that  it 
is  here  employed. 

The  purpose  for  discussing  this  phase  of  the  form 
of  railroad  bonds,  is  that  when  a  bond  that  is  nego- 
tiable in  the  strict  legal  meaning  of  that  term  is 
held  by  a  bona  fide  holder,  the  law  grants  such  bona 
fide  holder  of  such  an  instrument  certain  immunities 
and  rights  not  ordinarily  enjoyed  by  the  holders  of 
securities  generally. 

When  a  railroad  bond,  in  the  form  of  a  negotiable 
instrument  in  the  strict  legal  sense  just  mentioned,  is 
held  by  a  bona  fide  holder,  no  defense  can  be  set  up 
against  him,  when  trying  to  recover  on  it,  that  grew 
out  of  any  of  the  transactions  that  any  of  the  pre- 
vious holders  may  have  had  between  them,  or  with 
the  railroad  company;  nor  can  any  defense  then  be 
set  up  that  will  defeat  or  diminish  his  claim,  except 
such  as  deny  the  very  existence  and  life  of  the  in- 
strument itself.  Of  these  latter  defenses  forgery  and 
lack  of  delivery  of  the  instrument,  are  typical;  as 


24  RAILROAD  BONDS  AND  NOTES 

where  the  trustee's  certificate  has  been  forged  or  not 
delivered.  But  no  collateral  understandings,  or 
agreements,  or  violations  of  any  contract,  that  pre- 
vious holders  may  have  had  between  them  or  with 
the  railroad  company,  concerning  such  negotiable 
bond,  can  affect  a  bona  fide  holder. 

As  a  general  rule,  bona  fide  holders  are  not  affected 
by  the  misconduct  of  the  officers  of  the  railroad  com- 
pany in  the  management  of  its  affairs,  or  by  fraud 
in  the  issue  or  the  negotiation  of  the  bonds,  unless 
they  were  parties  to  it. 

If  the  bond  be  not  in  the  form  of  a  negotiable 
instrument,  as  here  meant,  each  successive  holder 
merely  succeeds  to  the  rights  and  liabilities  of  his 
predecessors  in  ownership,  and  in  this  way  whatever 
claims  might  have  been  set  up  against  any  holder  or 
owner  in  the  chain  of  ownership  may  be  set  up 
against  such  present  holder  or  owner. 

In  what  form  must  a  railroad  bond  be  in  order  to 
be  a  negotiable  instrument  in  the  legal  sense  under 
discussion?  The  usual  railroad  bond  is  in  that  form 
because  it  contains  the  promise  of  the  railroad  com- 
pany to  pay  a  certain  sum  of  money,  at  a  certain 
time,  to  bearer  (or  to  the  order  of  a  named  payee  and 
assigned  in  blank),  free  from  conditions  of  any  kind. 
The  elements  necessary  to  constitute  a  bond  a  nego- 
tiable instrument,  therefore,  and  all  of  which  must 
concur  are:  an  unconditional  promise  to  pay  a  defi- 
nite sum  of  money,  at  a  definite  time,  to  bearer  (or 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     25 

to  the  order  of  a  named  payee  and  assigned  by  him  in 
blank).  There  must  be  no  uncertainty  as  to  the 
amount  to  be  paid,  nor  as  to  the  time  when  it  shall 
be  paid ;  the  promise  to  pay  must  be  without  any  con- 
ditions and  must  not  be  dependent  upon  the  hap- 
pening of  any  event;  and  the  bond  must  be  payable 
to  bearer  or  to  the  order  of  a  named  payee  and  as- 
signed in  blank  by  the  latter. 

By  assignment  in  blank  is  meant  that  the  name  of 
the  person  to  whom  the  assignment  is  made  is  not 
mentioned  but  the  space  reserved  therefor  is  left 
blank  so  that  he  may  pass  it  on  from  hand  to  hand 
without  further  writing  of  any  kind. 

Experience  has  shown  that  "dry-as-dust"  informa- 
tion can  be  assimilated  only  by  iteration  and  reitera- 
tion ;  therefore,  at  the  risk  of  wearying  the  reader,  in 
view  of  its  importance,  the  elements  necessary  to 
make  the  bond  a  negotiable  instrument  are  again 
repeated:  the  bond  must  contain  an  unconditional 
promise  to  pay  a  definite  sum  of  money,  at  a  definite 
time,  to  bearer  (or  to  the  order  of  a  named  payee  and 
assigned  in  blank  by  him).  There  must  be  neither 
conditions  nor  uncertainty  attached  to  the  promise  to 
pay,  nor  to  the  time  of  payment,  nor  to  the  amount. 

Where  the  name  of  the  payee  is  left  blank,  the 
law  regards  it  as  payable  to  bearer. 

That  the  bond  is  numbered  does  not  affect  its  ne- 
gotiability; nor  does  the  provision  therein  contained 
that  it  may  be  redeemed  or  called  in,  or  paid  off,  in 


26  RAILROAD  BONDS  AND  NOTES 

any  way,  before  maturity.  And  neither  does  an 
option  to  convert  the  bond  into  the  capital  stock  of 
the  issuing  company;  nor  does  a  recital  in  the  bond, 
"that  it  may  be  registered  or  made  payable  only  on 
the  books  of  the  company,"  interfere  with  its  nego- 
tiability. 

The  interests  of  the  business  world  call  for  the  aid 
of  some  medium  for  the  exchange  of  its  values,  and 
negotiable  railroad  bonds  meet  in  many  ways  this 
requirement.  The  law,  therefore,  gives  them,  so  far 
as  it  can,  the  quality  of  negotiability  so  that,  while 
not  money,  they  may  pass  as  the  representatives  of 
money.  A  negotiable  railroad  bond  does  circulate 
in  many  transactions  upon  the  same  basis  as  money. 
The  law  accordingly  cloaks  a  bona  fide  holder  of  a 
negotiable  bond  with  the  protection  which  shields 
him,  as  was  just  described,  so  that  he  may  accept  and 
use  his  bond  as  if  it  were  money  itself.  This  is  an 
exception  to  the  general  rule  of  law.  The  necessities 
of  modern  commerce  have  created  it. 

However,  the  principle  is  not  carried  beyond  the 
business  interests  that  created  it.  And  the  negotia- 
bility of  the  bond  and  the  bona  fide  holdership  must 
both  be  present,  and  all  the  elements  that  constitute 
each  must  exist.  Therefore,  the  bond  must  contain 
an  unconditional  promise  to  pay  a  definite  sum  of 
money,  at  a  definite  time,  to  bearer  (or  to  the  order 
of  a  named  payee  and  assigned  in  blank  by  him) ; 
and  the  person  claiming  the  rights  of  a  bona  fide 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     27 

holder  must  have  purchased  such  bond,  not  directly 
from  the  railroad  company,  but  in  the  open  market 
in  the  regular  course  of  business,  in  good  faith,  be- 
fore its  maturity,  without  notice  or  knowledge  that 
there  was  anything  wrong  with  it  or  of  the  defenses 
sought  to  be  set  up  against  him,  and  he  must  have 
paid  therefor  its  fair  and  reasonable  value.  All  the 
elements  constituting  the  bond  a  negotiable  instru- 
ment, in  the  sense  here  used,  and  all  the  elements 
constituting  bona  fide  holdership  must  be  present; 
should  any  be  lacking,  notwithstanding  the  presence 
of  all  the  others,  the  case  does  not  fall  within  the 
principles  discussed. 

A  purchaser  in  the  open  market  is  not  bound  to 
make  a  close  and  critical  examination  of  a  bond  to 
avoid  the  charge  of  bad  faith. 

One  purchasing  a  bond  in  the  regular  course  of 
business  is  not  bound  to  make  inquiries  as  to  the 
rights  to  sell  nor  of  the  title  of  the  one  offering  it 
for  sale,  nor  to  take  any  special  precautionary  meas- 
ures to  ascertain  what  hostile  claims  may  exist  to 
defeat  it.  But  a  deliberate  avoidance  of  knowledge 
or  wilful  closing  of  the  eyes  to  facts,  when  circum- 
stances exist  that  are  likely  to  arouse  suspicion  in 
the  mind  of  a  reasonably  prudent  man,  will  be  con- 
strued to  have  the  same  effect  as  if  such  person  actu- 
ally had  the  knowledge  that  he  so  deliberately  avoids. 

To  be  a  bona  fide  holder  one  need  not  have  paid 
the  par  value  of  the  bond.  He  need  only  pay  the 


28  RAILROAD  BONDS  AND  NOTES 

reasonable  value  of  the  bond.  If  he  paid  much  less 
than  its  value,  it  is  a  fact  that  bears  on  the  question 
of  good  faith. 

A  bona  fide  holder  is  entitled  to  recover  the  face 
value  of  his  bond  no  matter  what  he  paid  for  it. 

Lost  or  stolen  coupon  bonds  or  notes,  or  coupons. 

If  a  bond  negotiable  in  form,  as  just  described,  be 
lost  or  stolen,  and  the  finder  or  thief  sell  it  to  one 
who  is  a  bona  fide  holder,  as  previously  discussed, 
such  purchaser  takes  a  good  title  to  it  and  is  entitled 
to  the  payment  of  his  bond  and  its  interest  as  against 
every  one. 

The  bond,  however,  must  be  negotiable  in  form, 
that  is,  it  must  be  a  promise  to  pay  a  definite  sum  of 
money,  at  a  specified  date,  free  from  conditions  of 
any  kind,  to  bearer  or  to  the  order  of  a  named  payee 
and  assigned  in  blank.  And  the  purchaser  must  be 
a  bona  fide  holder,  that  is,  he  must  have  purchased 
his  bond  before  its  maturity,  in  good  faith,  in  the 
usual  course  of  business,  that  is,  in  the  open  market, 
and  paid  therefor  its  fair  and  reasonable  value,  with- 
out any  knowledge  or  notice  that  there  was  anything 
wrong.  But  the  negotiability  of  the  bond  and  the 
bona  fides  of  the  holder  must  concur. 

Should  any  of  the  elements  of  negotiability  be 
missing,  then  the  purchaser  from  the  finder  or  thief 
does  not  get  a  good  title  to  it,  notwithstanding  that 
all  the  elements  of  bona  fide  holdership  are  present. 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      29 

And,  notwithstanding  that  the  bond  contains  all  the 
elements  necessary  to  make  it  a  negotiable  instru- 
ment, its  purchaser  from  the  finder  or  thief  does  not 
get  a  good  title  should  there  be  lacking  any  of  the 
elements  necessary  to  constitute  him  a  bona  fide 
holder. 

The  railroad  company  does  not  pay  to  more  than 
one  party,  of  course.  The  loss  falls  on  the  one  who 
lost  the  bond  or  from  whom  it  was  stolen.  The  bona 
fide  purchaser  from  a  thief  or  a  finder  of  a  stolen  or 
lost  negotiable  bond  gets  a  good  title  to  it  and  is 
entitled  to  payment  of  all  that  is  due  on  it,  and  all 
subsequent  holders  have  the  same  rights. 

Payment  may  be  refused  until  the  one  demanding 
it  shows  that  he  is  a  bona  fide  holder  and  that  the 
bond  is  negotiable  in  form.  He  is  entitled  to  its 
face  value,  notwithstanding  what  he  paid;  however, 
should  he  have  paid  much  less  than  its  actual  value 
it  will  have  a  material  bearing  on  his  bona  fides. 

In  a  proper  case,  the  payment  of  the  lost  or  stolen 
bond  may  be  enforced  by  the  party  who  lost  it  or 
from  whom  it  was  stolen;  and  a  court  of  equity,  it 
seems,  will  compel  the  execution  of  a  duplicate  bond 
in  its  place,  upon  the  party  applying  therefor  furnish- 
ing proper  and  sufficient  indemnity  to  the  railroad 
company  to  reimburse  it  should  it  be  called  upon  to 
pay  to  a  bona  fide  holder. 

The  rules  that  have  been  stated  here  with  refer- 
ence to  lost  or  stolen  bonds  apply  also  to  lost  or 


30  RAILROAD  BONDS  AND  NOTES 

stolen  notes  or  detached  coupons.  When  coupons 
are  still  attached  to  a  bond  or  note  they  are  incidents 
of  the  same  and  are  affected  by  whatever  affects  such 
bond  or  note. 

Altered  or  mutilated  bonds,  notes  or  coupons. 

An  intentional  changing,  alteration,  or  mutilation 
of  a  railroad  bond  in  any  of  its  material  parts  makes 
it  void  when  made  by  its  holder  or  owner  or  by 
another  at  his  instigation  or  with  his  consent. 

If  such  alteration  or  mutilation  be  unintention- 
ally made,  though  in  a  material  part,  it  will  not  affect 
the  bond;  nor  is  a  bond  affected  by  an  alteration  or 
a  mutilation  by  a  stranger  to  it,  though  in  a  material 
part,  when  made  neither  at  the  instigation  nor  with 
the  consent  of  its  owner  or  holder. 

An  alteration  in  an  immaterial  part  does  not  affect 
the  bond  no  matter  by  whom  made,  nor  under  what 
circumstances. 

Should  a  bond,  note  or  a  detached  coupon  become 
mutilated,  the  owner  may  notify  the  railroad  com- 
pany or  the  trustee,  whichever  shall  have  charge  of 
putting  out  the  issue,  and  a  duplicate  will  be  issued, 
when  a  provision  to  this  effect  is  contained  in  the 
mortgage.  It  usually  is. 

When  a  serial  number  on  a  bond  is  altered  or 
mutilated,  it  is  not  considered  as  in  a  material  part 
when  such  number  is  used  merely,  as  it  usually  is, 
for  the  purpose  of  identification.  But  when  num- 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     31 

bers  are  used  to  create  different  classes  among  the 
bonds  of  an  issue,  the  bonds  of  one  number  or  series 
of  numbers  possessing  certain  rights  not  given  to  the 
others,  then  the  numbers  enter  into  and  become  part 
of  the  contract  contained  in  the  bond  and  form  a 
material  part  of  it.  The  intentional  alteration  of 
serial  numbers  of  a  bond  in  such  a  case  by  its  owner 
or  with  his  consent  or  privity  will  annul  the  bond. 

A  purchaser  in  the  open  market  is  not  bound  to 
make  a  close  and  critical  examination  of  a  bond  to 
avoid  the  charge  of  bad  faith. 

The  same  rules  that  have  been  stated  here  with 
reference  to  altered,  changed  or  mutilated  bonds  ap- 
ply also  to  altered,  changed  or  mutilated  notes  or 
detached  coupons.  When  the  coupons  are  still  at- 
tached to  a  bond  or  note  they  are  incidents  of  the 
same  and  are  affected  by  whatever  affects  such  bond 
or  note. 

Coupon  bonds  and  coupons. 

A  coupon  bond  consists  of  two  parts;  the  bond 
itself,  which  represents  the  principal  sum  due,  and 
the  coupons  which  represent  the  interest  thereon. 

The  coupon  bond  may  be  regarded  as  an  inven- 
tion of  modern  commerce.  They  are  the  result  of 
the  need  in  the  money  market  of  a  security  that  can 
be  circulated  and  pass  from  hand  to  hand  without 
any  formality  of  transfer,  and  as  a  substitute  for 
money  to  a  certain  extent.  It  is  because  of  their 


32  RAILROAD  BONDS  AND  NOTES 

great  convenience  in  the  financial  world  that  the 
courts,  when  possible,  will  preserve  this  capacity  for 
ready  transfer,  and  give  coupon  bonds  and  coupons 
this  easy  marketability  and  currency. 

The  maturity  of  railroad  bonds  is  fixed,  as  a  rule, 
at  far  distant  periods,  averaging  about  fifty  years. 
A  set  of  certificates,  one  for  each  instalment  of  in- 
terest, from  the  time  the  bond  is  issued  until  the  date 
of  its  maturity  is  attached  to  the  bond.  At  the  ex- 
piration of  each  interest  period  when  the  interest 
that  the  certificate  represents  becomes  due,  it  is  cut 
off  and  presented  at  the  place  designated  for  pay- 
ment. These  certificates  may  be  detached  from  the 
bond  and  negotiated. 

The  term  coupons  from  the  French  couper,  to  cut, 
has  been  universally  adopted  to  designate  these  cer- 
tificates because  they  are  cut  off  when  collected  or 
negotiated. 

How  transferred;  "clear"  or  "marked"  bonds;  pre- 
sumption of  ownership. 

In  its  usual  form  a  coupon  bond  is  made  payable 
to  bearer,  or  payable  to  the  order  of  a  named  payee, 
or  the  space  left  for  the  name  of  the  payee  may  be 
left  blank. 

When  the  bond  is  payable  to  bearer,  or  the  name 
of  the  payee  is  left  blank,  it  is  transferred  from  hand 
to  hand  by  mere  manual  delivery  without  any  writ- 
ing or  formality  of  any  kind. 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      33 

A  holder  of  a  bond  with  the  space  for  the  name  of 
the  payee  left  blank,  has  the  legal  right  to  fill  in  his 
own  name  as  payee ;  while  this  is  a  legal  right  yet,  if 
done,  it  will  effect  the  bond  commercially,  for  it  is 
then  a  "marked  bond,"  as  the  expression  is  used  in 
financial  circles  and  will  not  be  accepted  in  transac- 
tions as  a  "good  delivery,"  in  that  condition.  It  is 
no  longer  a  "clear"  bond. 

When  the  name  of  the  payee  appears  in  the  bond 
it  can  be  transferred  only  by  such  named  payee,  who 
must  deliver  the  bond  accompanied  with  his  written 
assignment  of  it. 

The  coupon  bond  that  is  transferable  by  its 
manual  delivery  only,  and  which  has  never  been 
registered,  is  known  as  a  "clear  bond,"  and  is  ac- 
cepted in  all  transactions  as  a  "good  delivery."  It 
should  have  no  writing  on  it  of  any  kind  after  it  was 
put  out.  The  holder  should  never  deface  his  bond 
with  any  writing.  Any  memorandum  may  be  writ- 
ten on  a  separate  piece  of  paper  and  pinned  on. 

The  law  presumes  that  the  transfer  of  a  bond  or 
its  coupons  carries  with  it  the  title  of  ownership. 
Every  holder  of  a  coupon  bond  or  of  a  coupon,  pay- 
able to  bearer,  is  presumed  to  be  its  owner.  This 
presumption,  however,  is  not  conclusive  and  may  be 
shown  to  be  otherwise.  This  presumption  of  owner- 
ship merely  relieves  the  holder,  when  suing  on  his 
bond  or  coupon,  or  presenting  it  for  payment,  from 
proving  his  title  in  the  first  instance.  He  is  pre- 


34  RAILROAD  BONDS  AND  NOTES 

sumed  to  be  the  owner  until  this  is  disputed;  then 
he  must  prove  his  title. 

Effect  on  coupons  when  severed  from  bonds. 

Detached  coupons,  when  negotiable  in  the  strict 
legal  sense,  as  previously  discussed,  possess  to  a  great 
extent  the  characteristics  of  promissory  notes.  By 
such  negotiability  is  meant  that  the  coupons  are  pay- 
able to  bearer,  or  to  the  order  of  a  named  payee  and 
endorsed  in  blank  by  him;  and  that  they  contain  an 
unconditional  promise  to  pay  a  definite  sum  of  money 
on  a  designated  date.  This  is  the  form  in  which 
coupons  are  usually  issued. 

Should  coupons  comply  with  all  these  require- 
ments, as  they  usually  do,  then  when  detached  from 
their  bonds  they  become  independent  securities,  like 
so  many  promissory  notes.  They  are  then  no  longer 
mere  incidents  of  their  bonds  from  which  they  have 
been  severed,  but  each  is  a  separate  contract,  a  dis- 
tinct obligation  of  the  issuing  company.  They  be- 
come so  far  independent  of  the  bond  from  which  they 
have  been  detached  as  to  continue  their  negotiability 
and,  if  for  interest  already  accrued,  remain  in  full 
force  after  the  bond  itself  has  been  called  in,  re- 
deemed, or  for  any  reason  paid  or  canceled  before 
maturity.  As  to  cessation  of  interest  on  bond  called 
in,  see  Redeeming  bonds;  calling  bonds  in.  Page 

98. 

When  a  negotiable  coupon  falls  due  and  is  not 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      35- 

paid,  its  holder  is  entitled  to  sue  and  recover  on  it. 
He  may  sue  on  each  successive  coupon  as  it  falls  due 
and  is  not  paid.  And  the  fact  that  the  coupons  sued 
upon  are  from  bonds  secured  by  a  mortgage  does  not 
bar  the  suit;  but  in  realizing  on  his  judgment,  the 
holder  is  not  entitled  to  take  any  part  of  the  property 
covered  by  the  mortgage. 

While  the  coupon  negotiable  in  form  is  a  contract 
in  itself,  separate  and  independent  of  the  bond,  the 
law  holds  that  the  recovery  on  it  shall  be  based  upon 
and  be  in  conformity  with  the  obligation  contained 
in  the  bond. 

Should  the  detached  coupon,  sought  to  be  sued 
upon  separately,  be  lacking  in  any  of  the  elements 
of  negotiability  as  previously  described,  a  separate 
action  will  not  lie  upon  it;  it  may  then  only  be  sued 
upon  in  connection  with  the  bond  from  which  it  was 
severed  and  of  which  it  is  an  incident.  Some 
coupons  do  not  contain  promises  to  pay  the  sums 
therein  mentioned,  but  are  practically  merely  re- 
ceipts for  such  amounts.  Such  coupons  may  not  be 
sued  upon  separately,  as  they  then  lack  the  elements, 
so  many  times  discussed,  necessary  to  make  them  ne- 
gotiable instruments. 

A  coupon  which  is  not  negotiable  in  the  strict  legal 
sense  may  be  sometimes  regarded  as  such,  if  the  bond 
from  which  it  was  severed  is  itself  negotiable.  But 
on  this  proposition,  the  courts  of  the  various  States 
have  decided  differently.  In  some  States,  the  law 


36  RAILROAD  BONDS  AND  NOTES 

is :  that  the  coupon  shall  not  be  regarded  as  negotia- 
ble when  severed,  if  it  is  not  so  itself,  notwithstand- 
ing that  the  bond  from  which  it  was  severed  is 
negotiable,  unless  some  statute  makes  it  so.  The 
courts  of  the  other  States  hold  that  the  coupons  shall 
be  taken  in  connection  with  the  bonds  from  which 
they  were  severed,  and  though  the  coupon  itself  is 
not  negotiable  in  form,  if  the  bond  be  so,  the  coupon 
having  acquired  and  possessed  the  same  character- 
istics as  the  bond  while  attached  does  not  lose  these 
qualities  by  being  severed,  as  the  coupons  are  imbued 
with  the  strength  of  their  bonds. 

Should  there  be  a  conflict  between  the  terms  of  the 
bonds  and  the  coupons  the  terms  of  the  former  will 
prevail. 

Collection  of  coupons. 

To  collect  the  interest  which  the  coupon  repre- 
sents the  holder  must  cut  it  off  when  due  and  present 
it  at  the  place  designated  for  payment.  It  is  usually 
provided  in  the  mortgage  or  deed  of  trust,  that  the 
trustee  shall  pay  the  coupons,  or  that  the  railroad 
company  shall  maintain  an  office  or  agency  at  which 
coupons  may  be  presented  for  payment.  Should  no 
place  be  designated,  the  coupon  is  properly  presented 
at  the  office  of  the  railroad  company.  The  coupon 
may  be  presented  in  person  or  through  the  usual 
course  of  banking,  by  deposit  for  collection.  When 
the  holder  of  the  coupon  is  at  a  distance  from  the 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     37 

place  where  it  is  payable,  the  usual  and  better  course 
is  to  place  it  in  the  care  of  his  local  bank  about  a  week 
before  it  is  due.  Institutions  of  this  kind  are 
equipped  with  better  facilities  for  the  collection  of 
coupons  than  the  private  holder.  The  latter  must 
resort  either  to  the  registered  mail  or  express  com- 
panies to  send  it  to  the  place  of  payment. 

To  collect  a  coupon  the  original  bond  need  not  be 
presented.  Coupons  when  negotiable,  as  previously 
described,  become  a  separate  contract  and  distinct 
obligation  of  the  railroad  company,  and  are  paid 
without  regard  to  the  ownership  of  the  bond.  When 
the  coupon  is  paid  the  company,  or  the  trustees,  who- 
ever pays  it  is  entitled  to  its  possession  and  it  must 
be  surrendered,  just  as  a  promissory  note  or  other 
commercial  paper  is  turned  over  and  surrendered 
when  satisfied. 

Presentation  of  coupons  for  payment;  dispensing 
with  presentation;  effect  of  non-presentation. 

The  holder  of  a  coupon  does  not  lose  his  rights  to 
its  payment  because  he  has  not  presented  it  for  that 
purpose  at  the  time  when  and  the  place  where  it  is 
payable.  The  coupon  is  due  and  payable  on  the 
day  fixed  for  its  payment,  and  the  obligation  of  the 
railroad  company  to  pay  the  coupon  is  not  dis- 
charged until  it  has  actually  paid  it. 

If  the  company  had  the  money  at  the  time  and 
place  designated  for  payment,  the  holder,  while  he 


38  RAILROAD  BONDS  AND  NOTES 

does  not  lose  his  right  to  payment  of  the  coupon,  will 
lose  the  interest  on  it,  for  unpaid  coupons  that  have 
been  severed  from  their  bonds  draw  interest  from  the 
time  of  their  maturity.  See  Interest  on  over-due 
coupons.  Page  42.  If  the  company  had  no  money 
for  the  payment  of  the  coupons  at  the  time  and  place 
specified  for  payment,  the  coupons  need  not  have 
been  presented  and  there  is  no  loss  of  interest  on  such 
coupon. 

The  holder  of  a  coupon  has  the  right  without 
prejudice,  except  as  to  the  possible  loss  of  interest 
on  his  coupon,  to  await,  without  demand,  the  ma- 
turity of  the  bond  and  then  collect  his  principal  and 
interest,  or  at  any  intermediate  time  collect  the  in- 
terest then  due.  While  these  are  his  rights,  it  may 
be  regarded  as  a  rather  unbusiness-like  practise. 

Effect  of  payment  on  coupons;  cancellation. 

The  payment  of  a  coupon  extinguishes  it. 

Circumstances  that  tend  to  keep  them  alive  as 
obligations  of  the  railroad  company  should  be 
avoided.  When  paid  they  should  be  cancelled. 

There  are  cases  recorded  where  coupons  were  taken 
up  by  third  persons  interested  in  the  financial  condi- 
tion of  the  railroad  company,  under  an  arrangement 
with  it  by  which  such  third  persons  advanced  the 
necessary  money  and  took  up  the  coupons  as  they 
matured  and  held  them  as  continuing  obligations  of 
the  railroad. 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      39 

The  courts  have  held  such  a  transaction  to  be  a 
payment  and  an  extinguishment  of  the  coupons  so 
taken  up,  so  far  as  the  holders  of  the  bonds  and  the 
other  coupons  under  the  mortgage  were  concerned, 
where  they  were  not  parties  to  such  an  arrangement; 
but  as  between  the  railroad  company  and  such  third 
parties,  the  transaction  is  regarded  as  a  purchase  and 
not  as  a  payment  of  the  coupons  so  taken  up,  and 
that  such  third  parties  thereby  became  the  owners  of 
such  coupons  and  therefore  became  creditors  of  the 
railroad  company;  but  they  are  not  then  permitted 
recourse  to  the  mortgaged  property,  and  are  not  al- 
lowed to  prove  their  claims  against  such  property  in 
competition  with  the  holders  of  the  bonds  and  the 
other  coupons. 

However,  a  railroad  company  may  find  itself  tem- 
porarily embarrassed  financially,  and  to  stay  legal 
action  by  holders  of  unpaid  coupons,  and  prevent  a 
foreclosure  of  the  mortgage,  it  may  arrange,  with  the 
consent  of  the  holders  of  the  bonds  and  of  the  later 
maturing  coupons,  that  third  parties  may  take  up 
the  coupons  as  they  mature,  and  that  the  transaction 
shall  take  the  form  of  a  purchase  and  not  be  a  pay- 
ment of  such  coupons.  Under  such  an  arrangement 
the  coupons  are  kept  alive  as  outstanding  obligations 
of  the  railroad  company,  and  are  secured  by  the 
mortgage  and  share  in  the  security,  the  same  as  if 
in  the  hands  of  their  original  holders.  This  ar- 
rangement is  sometimes  provided  for  in  the  mortgage 


40  RAILROAD  BONDS  AND  NOTES 

itself,  or  it  may  be  made  upon  a  collateral  consent  of 
the  holders  of  the  bonds  and  the  subsequently  ma- 
turing coupons.  And  though  no  specific  arrange- 
ment be  made  to  that  effect,  yet  if  the  holders  of  the 
bonds  and  of  the  subsequently  maturing  coupons 
have  knowledge  of  such  an  arrangement  between  the 
railroad  company  and  such  third  parties,  and  the 
surrounding  facts  and  circumstances  clearly  show 
that  it  is  the  intention  of  all  parties  concerned  that 
such  transaction  shall  be  a  purchase  of  the  coupons 
by  which  they  are  to  be  kept  alive  and  share  in  the 
mortgage,  the  court  will  enforce  such  an  understand- 
ing in  favor  of  such  third  parties  thus  advancing 
these  monies,  and,  accordingly,  will  permit  them  to 
share  in  the  security  of  the  mortgage  with  all  the 
rights  of  holders  of  such  coupons. 

Overdue  coupons;  effect  on  bonds. 

When  the  bond  itself  is  due  and  not  paid  it  is  dis- 
honored and  is  no  longer  a  negotiable  instrument. 
Then  each  subsequent  holder  of  it  takes  it  subject 
to  all  defenses  and  objections  that  might  be  set  up 
either  to  defeat  or  diminish  a  recovery  on  it.  It  will 
be  remembered  that  one  of  the  elements  of  negotia- 
bility is  that  the  instrument  be  purchased  before 
maturity. 

Whether  or  not  the  non-payment  of  a  coupon  at- 
tached to  the  bond  will  affect  its  bond  not  yet  due 
with  dishonor  has  been  differently  decided.  And  it 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     41 

is  of  interest  to  examine  the  reasons  upon  which  these 
different  views  rest. 

The  law  seems  in  harmony  on  the  point  that  when 
the  principal  of  the  bond  is  payable  in  instalments, 
it  becomes  dishonored  by  the  failure  to  pay  any  one 
instalment.  This  rule,  however,  is  not  generally 
applied  to  the  non-payment  of  interest  and  the  fail- 
ure to  pay  the  interest-coupon  attached  to  the  bond 
does  not  of  itself  dishonor  the  bond.  In  one  juris- 
diction, this  view  is  rejected  and  no  distinction  is 
recognized  between  failure  to  pay  an  instalment  of 
interest  and  an  instalment  of  principal.  This  court 
holds  that  if  interest  be  over-due  and  unpaid,  and 
this  fact  appears  on  the  face  of  the  bond  as  it  does 
when  the  coupons  remain  attached,  it  is  sufficient  to 
put  the  purchaser  on  his  guard  that  the  bond  has  been 
dishonored  by  the  non-payment  of  the  coupon,  and 
the  bond  will  be  then  subject  to  all  defenses  that 
may  defeat  or  diminish  its  payment. 

The  decisive  weight  of  authority,  however,  re- 
gards coupon  bonds  as  a  class  of  negotiable  securities, 
the  principal  of  which  is  payable  only  at  the  end  of 
many  years,  with  interest  payable  periodically;  and 
that  the  holder  of  such  bond  may  wait  until  the  ma- 
turity of  the  bond  itself  before  he  demands  any  in- 
terest. Unpaid  coupons  attached  to  the  bond,  there- 
fore, do  not  affect  the  bond.  The  ease  with  which 
the  over-due  coupons  can  be  removed  from  a  bond 
not  yet  due,  before  transferring  it,  and  thereby  avoid 


42  RAILROAD  BONDS  AND  NOTES 

the  objection  to  their  presence,  would  tempt  the  fre- 
quent commission  of  fraud.  Further,  a  railroad 
company  may  not  put  out  the  bonds  until  one  or 
more  coupons  are  past  due.  While  it  is  the  custom 
to  cut  off  the  over-due  coupons,  under  such  circum- 
stances, they  may  be  permitted  to  remain,  though  it 
is  quite  unusual  to  do  so,  and  their  amount  included 
in  the  purchase  price. 

It  may  be  said  as  a  general  proposition  that  the 
presence  of  over-due  coupons  on  a  bond  is  not  suffi- 
cient in  itself  to  dishonor  the  bond ;  yet,  the  fact  that 
the  interest  is  overdue  is  material  and  important, 
and  will  be  considered  in  connection  with  other  cir- 
cumstances as  evidence  of  the  good  or  the  bad  faith 
of  the  purchaser. 

Interest   on   overdue   coupons,   attached   and   de- 
tached; rates  of  interest  allowable. 

Detached  coupons  when  negotiable  in  form,  as 
was  seen,  are  regarded  as  securities  so  separate  and 
distinct  from  their  bonds  that  they  may  be  sued  upon 
independently  of  and  without  the  production  of  the 
bond.  And  under  certain  circumstances  they  draw 
interest  like  other  obligations  for  the  payment  of 
money. 

As  a  general  rule,  interest  is  allowed  only  on 
principal.  But  this  rule  has  been  modified  somewhat 
in  the  case  of  coupons,  negotiable  in  form,  that  have 
been  detached  from  their  bonds  and  negotiated,  be- 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     43 

cause  when  negotiable  in  form  and  detached  and 
negotiated  they  are  separate  and  independent  securi- 
ties. Under  such  conditions  they  draw  interest  from 
the  time  of  their  maturity  like  other  securities. 

Interest  on  overdue  coupons,  detached  from  their 
bond,  though  it  is  interest  on  overdue  instalments  of 
interest,  is  not  regarded  as  usury. 

But  when  the  coupons,  whether  remaining  attached 
to  their  bonds  or  detached  therefrom,  are  in  the 
possession  of  the  holder  of  the  bond  itself,  a  different 
question  presents  itself.  While  there  is  a  conflict  in 
the  decisions  of  the  courts  of  the  different  States  on 
this  point,  the  weight  of  authority  holds  that  when 
the  coupon  remains  in  the  hands  of  the  holder  of  the 
bond,  whether  attached  or  detached,  they  are  merely 
incidents  of  the  bond  and  are  promises  for  the  pay- 
ment of  its  interest.  The  coupon,  under  such  cir- 
cumstances, is  regarded  strictly  as  interest  and  not 
as  a  separate  security,  and  no  interest  will  be  allowed 
on  this  overdue  interest.  But  when  the  coupons  are 
negotiable  in  form  and  have  been  detached  and  are 
held  by  one  other  than  the  holder  of  the  bond  itself, 
interest  is  allowed  on  them  from  the  dates  of  their 
maturity. 

The  rate  of  interest  on  the  overdue  coupons  may 
be  fixed  in  the  mortgage,  or  by  other  arrangement 
between  the  parties,  and  the  rate  of  interest  thus 
agreed  upon  will  be  enforced  provided  it  does  not 
violate  any  law. 


44  RAILROAD  BONDS  AND  NOTES 

Where  there  is  no  provision  made  by  the  parties, 
the  rate  of  interest  on  the  overdue  coupons,  in  most 
States,  is  the  legal  rate  of  interest  at  the  place  where 
they  are  payable,  without  regard  to  the  rate  of  inter- 
est the  coupon  bears. 

However,  the  courts  of  some  States  hold  that  the 
rate  of  interest  payable  on  coupons  after  maturity, 
where  there  is  no  provision  to  the  contrary,  shall 
continue  the  same  as  they  bore  before  maturity. 
Notwithstanding  this  latter  ruling,  should  a  coupon 
holder  sue  and  reduce  his  claim  to  a  judgment,  his 
judgment  thus  obtained  (which  has  merged  and  dis- 
posed of  his  original  claim  on  his  coupon),  will  bear 
the  legal  rate  of  interest  fixed  by  the  law  of  the 
State  in  which  the  judgment  is  had.  This  rule  with 
regard  to  the  rate  of  interest  that  judgments  shall 
bear  is  the  same  in  all  the  States. 

The  security  for  the  coupons ;  priorities  and  prefer- 
ences. 

The  coupons  are  secured  by  the  same  mortgage 
that  secures  the  bonds. 

The  bonded  debt  of  the  railroad  company  consists 
of  the  bonds  and  the  interest.  The  interest-coupons, 
therefore,  are  a  part  of  that  debt.  An  assignment  of 
a  part  of  the  mortgage  debt,  such  as  a  bond  or  a  de- 
tached coupon,  carries  with  it  a  corresponding  inter- 
est in  the  mortgage  security.  Consequently  the 
holders  of  detached  coupons  are  entitled  to  share  in 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     45 

the  proceeds  of  the  security  proportionately  with  the 
holders  of  the  bonds. 

Claims  for  interest  that  accrue  during  the  fore- 
closure are  entitled  to  the  same  rights  as  claims  for 
the  interest  theretofore  due  and  unpaid.  Should 
the  money  realized  from  the  sale  of  the  mortgaged 
property  be  insufficient  to  pay  all  in  full,  then  the 
coupons  and  the  bonds  bear  the  loss  proportionately, 
unless  there  is  some  arrangement  agreed  upon  to  the 
contrary.  Then  such  other  arrangement  will  be 
enforced. 

Ordinarily,  coupons  are  paid  in  the  order  in  which 
they  fall  due.  But,  in  foreclosure  proceedings  they 
are  paid  without  regard  to  when  they  fall  due,  and 
all  stand  on  the  same  footing.  Then  priority  in 
their  maturity  gives  no  priority  in  their  payment. 

In  applying  these  rules,  the  courts  give  effect  to 
the  equitable  principles  of  law  which  give  equality 
among  persons  having  a  common  right  to  payment 
out  of  a  fund  provided  for  the  benefit  of  all.  And 
this  rule  is  not  departed  from  without  clear  evidence 
of  an  intention  to  give  one  a  preference  over  the 
other. 

Provisions  for  preference  may  be  and  sometimes 
are  made  in  railroad  mortgages.  Accordingly,  a 
railroad  mortgage,  securing  several  classes  of  bonds 
and  their  coupons,  may  give  certain  priorities  and 
preferences  in  payment  to  one  class  over  another;  or 
it  may  prefer  the  coupons  over  the  bonds  themselves; 


46  RAILROAD  BONDS  AND  NOTES 

or  it  may  prefer  coupons  in  the  order  in  which  they 
fall  due;  or  it  may  make  such  other  arrangement  as 
has  been  agreed  upon  by  the  parties.  The  courts 
recognize  and  enforce  such  stipulations  in  railroad 
mortgages. 

Rights  of  coupon  holders  as  to  each  other;  bona 
fide  holders  of  coupons. 

Coupons  may  be  affected  by  the  original  invalid- 
ity of  their  bonds;  but,  as  among  themselves,  one 
coupon  is  not  affected  by  any  claims  or  defense  that 
may  exist  against  the  others. 

When  the  coupon  is  entitled  to  stand  as  a  separate 
and  independent  negotiable  security,  it  is  protected 
by  law  in  the  hands  of  a  bona  fide  holder,  so  that  it 
shall  be  subject  in  his  hands  only  to  such  defenses  as 
deny  its  legal  existence,  that  is,  showing  the  non- 
existence  of  the  facts  necessary  to  give  it  legal  life, 
such  as  forgery,  lack  of  power  to  make  the  issue,  that 
the  coupon  was  not  delivered,  that  it  is  not  properly 
certified  by  the  trustee,  or  that  his  certificate  is 
forged.  The  same  rules  apply  to  negotiable  cou- 
pons as  to  negotiable  bonds.  See  Rights  of  bona 
fide  holders  of  negotiable  bonds.  Page  23. 

Statutes  of  limitations;  as  to  the  bonds,  as  to  the 
coupons. 

A  party  having  the  right  to  sue  must  not  sleep  on 
his  rights;  he  must  bring  his  action  into  court  with 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     47 

reasonable  diligence.  The  statutory  laws  of  the 
various  States  have  classified  the  different  kinds  of 
actions  and  have  declared  the  periods  within  which 
each  class  shall  be  commenced.  Actions  on  written 
instruments  which  have  been  executed  by  the  party 
sought  to  be  charged  by  putting  his  seal  to  the  paper, 
must  be  sued  upon,  as  a  quite  general  rule,  within 
twenty  years  from  the  time  that  the  right  to  sue  first 
existed.  Actions  on  written  instruments,  to  which 
the  seals  of  the  parties  to  be  sued  have  not  been 
attached,  must  be  sued  upon,  as  a  general  rule,  within 
six  years  from  the  time  the  right  to  sue  first  existed. 
Should  the  action  be  brought  after  such  period  has 
expired,  it  may  be  defeated  by  the  defense  that  it 
is  "outlawed"  by  the  statutes  of  limitations,  as  these 
statutes  are  called. 

The  statutes  of  limitation  begin  to  take  effect  or 
to  "run,"  as  the  expression  is,  from  the  time  that  the 
right  to  sue  first  existed ;  which,  in  the  case  of  bonds 
and  detached  coupons,  is  from  the  time  they  became 
due  and  payable,  according  to  their  terms,  and  were 
not  paid.  Should  a  demand  be  necessary,  the  stat- 
ute begins  to  run  from  the  time  the  demand  was 
made  and  not  complied  with. 

A  railroad  bond  is  a  written  instrument  executed 
under  the  seal  of  the  railroad  company  and,  there- 
fore, the  twenty  years  statute  of  limitation  applies. 

The  same  statute  of  limitation  of  twenty  years 
is  applied  to  detached  coupons.  Ordinarily,  the 


48  RAILROAD  BONDS  AND  NOTES 

coupon  is  a  written  instrument  not  under  seal,  and 
it  seems,  therefore,  that  the  six  years  statute  should 
apply;  but  the  courts  have  held  that  the  coupon  so 
strongly  partakes  of  the  nature  of  the  bond  from 
which  it  has  been  severed  that  the  twenty  years 
statute  shall  apply.  But  the  time  in  the  case  of 
detached  coupons  from  which  the  statute  of  limita- 
tions shall  begin  to  run  is  from  the  time  such  coupon 
was  payable,  without  regard  to  the  maturity  of  the 
bond  or  when  the  bond  became  payable. 

Registered  bonds;  the  act  of  registration;  effect  on 
principal  and  on  interest. 

While  the  coupon  bond  has  the  advantage  of  easy 
negotiation,  and  therefore  commends  itself  to  those 
seeking  a  security  that  may  be  quickly  transferred 
and  readily  converted  into  cash,  and  which  is  often 
accepted  as  the  representative  of  money,  it  has  the 
disadvantage  of  the  risks  that  attend  its  loss  or  theft. 
The  registered  bond,  therefore,  is  sought  by  those 
seeking  a  permanent  form  of  investment.  The  dan- 
ger attending  loss,  destruction,  or  theft,  is  avoided 
in  the  registered  form  of  bond. 

A  registered  bond  is  one  that  bears  the  name  of 
its  payee  on  its  face,  and  is  registered  in  the  name 
of  its  payee  on  the  books  of  the  railroad  company, 
or  of  the  fiscal  agency  designated  for  that  purpose. 

Railroad  mortgages  invariably  provide  that  the 
person  in  whose  name  the  bond  shall  be  registered, 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      49 

so  far  as  the  railroad  company  or  the  trustee  shall 
be  concerned,  shall  be  regarded  as  its  owner,  and 
that  payment  of  all  or  any  part  of  the  bond  shall  be 
made  only  to  such  registered  owner  or  his  order. 
The  interest  and  the  principal  of  the  bond  is  paid 
only  to  him  who  appears  on  the  registry  as  owner  of 
the  bond. 

The  registered  bond  has  no  coupons. 

A  registered  bond  may  be  issued  in  the  first  in- 
stance; or  the  holder  of  a  coupon  bond,  under  the 
privilege  usually  granted  him  by  railroad  mortgages, 
may  have  it  registered. 

The  holder  of  a  coupon  bond  who  wishes  to  reg- 
ister it  presents  it  to  the  railroad  company  or  the 
fiscal  agency,  when  one  is  designated  for  that  pur- 
pose, whereupon  the  coupons  are  cut  off  and  sur- 
rendered. The  name  of  the  holder  is  then  entered 
on  the  registry  or  books  kept  for  that  purpose  and 
an  indorsement  made  on  the  bond  noting  its  regis- 
tration; or  a  new  bond  may  be  issued,  with  the  name 
of  the  registered  owner  appearing  on  its  face  as 
payee. 

When  the  new  registered  bond  is  issued  in  the 
place  of  the  surrendered  coupon  bond,  the  latter  is 
destroyed.  When  the  coupon  bond  is  not  surren- 
dered, the  coupons  are  cut  off,  and  the  body  of  the 
coupon  bond  is  used  and  the  notation  made  that  it 
is  registered  in  the  name  of  the  registered  owner, 
as  payee.  The  body  of  the  coupon  bond  is  the  same 


50  RAILROAD  BONDS  AND  NOTES 

as  that  of  the  registered  bond,  with  the  exception 
of  those  facts  that  show  the  registration,  and  also 
that  the  coupons  are  missing. 

Should  no  fiscal  agency  be  designated,  then  the 
bond  is  presented  for  registration  to  the  railroad 
company  at  its  general  office.  Should  the  person 
desiring  to  register  a  bond  live  at  a  distance  from 
the  place  of  registration,  the  practise  usually  fol- 
lowed is  to  send  the  bond  by  registered  mail  or  ex- 
press. The  local  banks  or  bankers  take  care  of  such 
matters  for  clients. 

Transfer  of  registered  bonds ;  converting  registered 
bonds  into  coupon  bonds ;  payment  of  interest. 

The  transfer  of  a  registered  bond  is  made  by  the 
last  registered  owner  executing  a  written  assignment 
or  power  to  transfer  the  same,  in  a  form  approved 
by  the  railroad  company,  and  delivering  both  to  the 
new  owner.  Some  bonds  have  the  form  printed  on 
their  backs. 

Until  this  is  done  the  bond  is  like  a  check,  pay- 
able to  a  named  payee  and  which  has  not  been  en- 
dorsed and  transferred  by  him. 

The  bond  is  in  turn  registered  by  the  person  to 
whom  it  has  thus  been  transferred  by  the  registered 
owner  by  presenting  it  at  the  place  for  registration 
for  that  purpose. 

It  is  usually  provided  in  railroad  mortgages  that, 
after  registration,  no  transfer  shall  be  valid  so  far 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      51 

as  the  railroad  company  is  concerned  unless  made 
on  its  books  and  by  the  registered  owner  in  person, 
or  by  his  attorney  duly  authorized  in  writing,  and 
similarly  noted  on  the  bond. 

The  stock  exchanges  and  the  registries  of  some 
of  the  railroad  companies  have  rules  with  regard 
to  the  transfer  of  registered  bonds  that  they  insist 
shall  be  strictly  observed.  A  disregard  of  these  re- 
quirements, even  in  the  slightest  detail,  may  cause 
annoyance  by  the  delay  in  correction.  Registered 
bonds,  as  a  rule,  are  not  regarded  as  "good  deliv- 
eries." 

Where  the  bond  is  registered  in  the  name  of  a 
person  since  deceased,  the  endorsement,  assignment, 
or  power  of  attorney  should  be  made  and  executed 
by  the  executor  or  administrator,  as  the  case  may 
be. 

Registered  bonds  may  be  presented  to  the  rail- 
road company,  or  its  fiscal  agency  designated  for 
that  purpose,  should  the  terms  of  the  mortgage  grant 
this  privilege,  to  have  noted  on  them  that  they  are 
payable  to  bearer.  Their  negotiability  is  thus  re- 
stored and  they  may  then  be  transferred  by  their 
manual  delivery  from  hand  to  hand,  without  any 
indorsement,  written  assignment,  or  power,  or  any 
formality  other  than  their  physical  delivery,  just 
as  if  they  were  coupon  bonds  originally  and  had 
never  been  registered.  A  new  set  of  coupons  are 
then  issued  to  accompany  the  bond. 


52  RAILROAD  BONDS  AND  NOTES 

Interest  on  a  fully  registered  bond  is  paid  when 
due  directly  to  the  registered  owner  of  the  bond; 
there  is  no  need  for  presentation  of  the  bond  itself. 
The  custom  is  to  draw  a  check  to  the  order  of  the 
last  registered  owner  and  mail  it  to  him  to  his  ad- 
dress as  it  appears  on  the  registry.  The  payment 
of  principal  or  interest,  or  both,  may  be  made  to 
another  pursuant  to  the  order  of  the  registered 
owner. 

Where  the  bond  is  registered  as  to  principal  only 
and  the  coupons  are  not  destroyed  but  permitted  to 
continue  as  representative  of  interest,  then  such  cou- 
pons are  transferrable,  after  they  are  severed  from 
the  bond,  by  their  manual  delivery,  just  as  if  they 
were  the  coupons  of  a  coupon  bond.  The  principal 
only  is  paid  to  the  registered  owner  and  the  interest 
is  paid  to  whomsoever  presents  the  coupon  without 
regard  to  the  ownership  of  the  bond  itself. 

Registration  of  coupon  bonds  as  to  principal  only. 

The  coupon  bond  may  be  registered  in  its  entirety, 
that  is,  as  to  both  principal  and  interest  as  just  dis- 
cussed; or  it  may  be  registered  as  to  the  bond  (prin- 
cipal) only,  and  the  coupons  permitted  to  remain 
negotiable  as  theretofore.  Then  the  principal  of 
the  bonds  is  payable  to  the  registered  owner  and  the 
coupons  are  paid  to  their  holder  or  holders  without 
regard  to  the  ownership  of  the  bond  or  its  registra- 
tion. 


VARIOUS  KINDS  OF  BONDS  AND  NOTES     53 

The  coupons  continue  their  currency  and  may  be 
circulated  as  if  the  bond  had  not  been  registered. 

Registration  of  both  bonds  and  coupons. 

A  form  of  registration  rarely  used  is  that  by  which 
the  bond  itself  is  registered  and  the  coupons  are  also 
registered.  Then  principal  and  interest  are  paid 
only  to  the  registered  owner  of  each.  The  only  dif- 
ference between  this  kind  and  the  usual  form  of 
registered  bond  is  in  the  mode  of  collection  of  in- 
terest. The  interest  of  the  ordinary  registered  bond 
is  sent  to  the  last  registered  owner  of  the  bond;  the 
interest  on  the  bond  registered  both  as  to  the  bond 
and  the  coupons  is  collected  by  means  of  the  cou- 
pons. The  interest  is  paid  to  the  registered  owner 
of  the  coupons. 

When  the  set  of  coupons  become  registered  and 
this  fact  is  noted  on  their  face,  they  lose  their  ne- 
gotiability and  capacity  to  pass  title  by  delivery 
from  hand  to  hand,  but  must  then  be  assigned  in 
writing  as  in  the  case  of  the  bond  itself,  and  the  pro- 
visions for  the  registration  by  subsequent  holders  or 
owners  of  the  bonds  apply  to  the  same  situation  with 
relation  to  the  coupons.  See  Registered  bonds:  the 
act  of  registration;  effect,  etc.  Page  48. 

Interchangeable  or  convertible  bonds. 

The  privilege  to  change  or  convert  a  coupon  bond 
into  a  registered  bond,  or  to  re-convert  or  change 


54  RAILROAD  BONDS  AND  NOTES 

back  the  registered  bond  into  a  coupon  bond,  is  quite 
generally  conferred  by  railroad  mortgages.  Bonds 
with  these  privileges  are  usually  called  "convertible 
bonds."  The  same  term  is  also  employed  to  desig- 
nate a  bond  which  gives  its  owner  or  holder  the  right 
to  convert  it  into  the  capital  stock  of  the  issuing 
company.  See  Provisions  for  converting  bonds  into 
capital  stock  of  the  railroad  company.  Page  105. 

Should  the  owner  of  a  registered  bond  desire  to 
change  it  into  a  coupon  bond,  he  must  have  a  new 
coupon  bond  issued  to  him,  or  at  least  a  new  set  of 
coupons  must  be  issued  and  a  notation  made  on  the 
old  bond  that  it  is  thenceforth  payable  to  bearer. 

When  the  coupon  bond  has  been  registered  in  the 
ordinary  form,  that  is,  as  to  principal  and  interest, 
it  is  shorn  of  its  coupons.  Having  been  thus  con- 
verted from  a  coupon  bond  to  a  registered  bond  it 
cannot  be  reconverted  into  a  coupon  bond  because 
the  coupons,  which  are  an  indispensable  part  of  a 
coupon  bond,  no  longer  exist.  A  new  set  of  cou- 
pons are  necessary.  The  usual  custom  is  to  sur- 
render the  old  bond  and  a  new  coupon  bond  is  is- 
sued in  its  place,  with  the  matured  coupons  cut  off. 

A  bond  registered  as  to  the  bond  (the  principal) 
only,  with  the  coupons  continuing  their  negotiabil- 
ity may  be  reconverted  into  an  ordinary  coupon  bond 
without  much  difficulty.  This  is  done  by  an  en- 
dorsement on  the  bond  by  the  registered  owner  that 
it  is  payable  to  bearer,  and  by  a  similar  notation 


VARIOUS  KINDS  OF  BONDS  AND  NOTES      55 

by  the  railroad  company  or  its  representatives  at 
its  fiscal  agency.  The  negotiability  of  the  bond 
which  as  to  its  principal  had  been  temporarily  with- 
drawn is  thus  restored. 

Railroad  bonds  are  usually  secured  by  a  mort- 
gage or  "deed  of  trust,"  as  it  is  sometimes  called. 
These  terms  are  used  interchangeably.  The  follow- 
ing chapter  is  addressed  to  an  analysis  of  the  usual 
form  of  railroad  mortgage  and  a  discussion  of  its 
various  provisions,  including  the  lien  of  the  mort- 
gage and  the  protection  and  rights  it  gives  the  hold- 
ers of  the  securities  issued  under  it,  under  various 
conditions,  and,  treating,  too,  of  the  sinking  fund, 
refunding,  redeeming,  calling  in,  serial  payment,  and 
conversion  arrangements. 


CHAPTER  III 

RIGHTS  AND  REMEDIES   WITH   RELATION  TO  THE 
MORTGAGE    OR   DEED    OF    TRUST 

Purpose  of  the  mortgage  or  deed  of  trust. 

The  mortgage,  or  deed  of  trust  as  it  is  sometimes 
called,  is  the  instrument  or  document  that  secures  the 
bonds  and  their  interest  by  charging  certain  property 
of  the  railroad  company  with  their  payment. 

In  some  States  the  mortgage  or  deed  of  trust  is 
unnecessary  as  their  statutes  declare  that  the  bonds 
of  railroad  companies  shall  be  a  lien  upon  all  its 
property  from  the  time  of  their  issue  without  any 
mortgage. 

The  terms  "mortgage"  and  "deed  of  trust"  are 
used  interchangeably.  They  mean  the  same  docu- 
ment or  legal  instrument.  The  more  popular  term 
is  mortgage,  and  it  will  be  used  in  these  pages. 

The  mortgage  pledges  the  property  therein  men- 
tioned, and  charges  it  with  a  lien  in  favor  of  the 
bonds  and  coupons  it  secures,  so  that  their  holders 
shall  have  the  exclusive  right  to  take  this  property 
in  satisfaction  of  their  claims,  and  be  paid  out  of  it 
in  full,  before  any  other  creditor,  who  is  not  secured 

56 


MORTGAGE  OR  DEED  OF  TRUST    57 

by  a  lien  on  this  mortgaged  property  prior  or  su- 
perior to  that  of  the  mortgage,  receives  anything. 

General  description  of  the  mortgage. 

The  mortgage  is  executed  by  the  railroad  com- 
pany, as  mortgagor,  to  the  trustee,  as  mortgagee. 
The  bondholders  are  not  directly  made  parties  to 
the  mortgage;  but  it  is  with  the  same  effect  as  if 
each  bondholder  were  made  a  party  to  it.  The 
trustee  is  the  party  to  the  mortgage  in  behalf  of 
the  bondholders.  The  mortgage  is  enforced  by  the 
trustee  for  the  benefit  of  whomsoever  may  be  the 
holders  of  the  outstanding  bonds  and  coupons  under 
such  mortgage  at  the  time  it  is  enforced. 

The  trustee,  generally  speaking,  represents  all  the 
holders  of  the  securities  under  the  mortgage.  He  is 
their  trustee :  the  guardian  of  their  rights  with  rela- 
tion to  that  mortgage.  The  mortgage  is  made  to 
him  as  a  party  instead  of  to  the  bondholders  di- 
rectly, because  trusteeship  of  this  character  is  neces- 
sary when  a  mortgage  is  given  to  secure  a  large 
issue  of  railroad  bonds.  It  would  be  impracticable 
to  make  each  bondholder  a  party  to  the  mortgage, 
as  each  transfer  of  a  bond  would  necessitate  the 
transfer  of  the  owner's  interest  in  the  mortgage. 
This  bewildering  number  of  transfers  would  retard 
the  ready  negotiation  of  rajlroad  bonds  secured  by 
mortgage,  and  correspondingly  impair  their  value. 
It  would  be  impracticable  to  have  this  large  num- 


58  RAILROAD  BONDS  AND  NOTES 

her  of  bondholders,  unknown  to  each  other,  and 
scattered  over  the  civilized  world,  unite  to  take  legal 
action.  It  becomes  necessary,  therefore,  that  one 
or  several  representatives  shall  be  chosen  to  act  for 
all.  Hence  the  trusteeship  of  railroad  mortgages. 

The  effect  of  the  mortgage  is  to  pass  the  title  and 
ownership  of  the  property  it  covers  (usually  the  en- 
tire road  or  a  branch  line,  and  sometimes  other  prop- 
erty as  stocks  and  bonds  of  other  companies,  etc.) 
to  the  trustee;  by  a  provision  in  the  mortgage  the 
railroad  company  is  permitted  to  retain  possession 
of  the  road  that  is  mortgaged,  and  to  use  and  to 
operate  it,  and  is  entitled  to  the  income  it  earns  until 
it  defaults  under  the  mortgage.  By  a  default  is 
meant  a  failure  to  pay  the  interest,  or  the  principal 
of  the  bonds,  or  an  instalment  of  principal;  or  an 
omission  on  the  part  of  the  railroad  company  to  do 
something  it  has  undertaken  to  do  in  the  mortgage, 
which  is  generally  an  act  intended  to  safeguard  and 
to  protect  the  mortgaged  property  so  that  the  se- 
curity of  the  bondholders  will  be  preserved  to  them ; 
or  the  doing  of  some  act  with  respect  to  the  mort- 
gaged property  that  jeopardizes  the  security.  Upon 
such  a  default  the  mortgage  usually  authorizes  the 
trustee  to  take  possession  of  the  mortgaged  road  (if 
securities  are  mortgaged  they  are  turned  over  to 
the  trustee  upon  the  execution  of  the  mortgage)  and 
to  operate  such  mortgaged  road  and,  if  necessary, 
to  sell  it  to  satisfy  the  claims  of  his  bondholders 


MORTGAGE  OR  DEED  OF  TRUST          59 

against  it;  he  may  sell  sometimes  without  entering 
into  possession  and  operating  it.  The  securities 
that  have  been  turned  over  to  him  under  the  mort- 
gage are  sold  by  him ;  should  the  deposited  securities 
consist  of  bonds  of  other  companies  secured  by  mort- 
gages on  their  property  he  may  have  to  foreclose  the 
mortgage  securing  such  deposited  bonds,  should  the 
company  issuing  them  default  under  their  mortgage. 
In  addition  to  these  special  powers  that  railroad 
mortgages  usually  grant  trustees,  he  may  apply  to 
the  court  to  foreclose  the  mortgage  and  sell  the 
property  under  its  direction  asking  that,  in  the  mean- 
time, a  receiver  be  appointed  to  take  possession  of 
the  mortgaged  road  until  it  is  sold  on  foreclosure 
sale,  or  until  the  property  is  taken  over  in  the  course 
of  the  reorganization  of  the  road.  While  the  re- 
ceiver holds  such  mortgaged  road,  he  is  usually  au- 
thorized by  the  court  to  operate  the  road. 

Power  of  railroad  company  to  mortgage  its  prop- 
erty and  its  franchise  to  operate;  opinion  of 
counsel. 

In  some  States,  railroad  companies  have  the  same 
powers  as  ordinary  private  corporations  to  mortgage 
their  property,  including  their  franchise  to  operate, 
for  any  lawful  purpose  necessary  to  carry  out  the 
objects  for  which  they  were  incorporated,  unless  this 
power  is  expressly  negatived  by  its  charter. 

In  other  States,  and  by  the  weight  of  authority, 


60  RAILROAD  BONDS  AND  NOTES 

railroad  corporations  do  not  have  this  same  power 
that  ordinary  private  corporations  have,  and  may 
neither  mortgage  their  franchise  nor  their  property 
where  its  sale  would  interfere  with  the  operation  of 
the  road,  unless  this  power  is  granted  by  their  char- 
ters. 

These  latter  authorities  rest  their  conclusions  upon 
the  distinction  that  railroad  corporations  are  "quasi 
public"  corporations,  immediately  connected  with 
the  public  welfare,  serving  public  needs  and  necessi- 
ties; that  they  receive  from  the  people  of  the  state 
the  necessary  franchises  or  special  privileges  to  run 
their  roads  between  certain  terminii  and  over  certain 
territory  to  the  exclusion  of  others;  that  by  accept- 
ing these  franchises  they  assume  the  duty  to  main- 
tain their  roads  and  to  continue  them  in  existence 
and  operation;  and  that  they  may  not  by  mortgage 
or  sale  of  their  property  or  franchises  abandon  or 
interfere  with  the  performance  of  these  duties,  un- 
less the  State  from  which  they  receive  them  con- 
sents. 

The  State  having  granted  this  exclusive  privilege 
to  operate  a  railroad  between  certain  terminii  and 
over  certain  territory  to  one  corporation  to  the  ex- 
clusion of  others  continues  to  regulate  its  exercise. 
As  the  mortgage  may  result  in  a  sale,  the  franchise 
may  not  be  mortgaged  without  the  permission  of  the 
legislature  that  granted  it.  However,  the  power  to 
mortgage  their  franchises  to  operate  is  usually  given 


MORTGAGE  OR  DEED  OF  TRUST  61 

to  railroad  companies  by  the  legislatures  of  most 
States. 

The  franchise  referred  to  in  the  preceding  dis- 
cussion is  the  special  privilege  to  operate  a  railroad. 
It  must  be  distinguished  from  the  franchise  to  exist 
as  a  corporation. 

The  franchise  to  exist  as  a  corporation  is  the  right 
the  legislature  grants  to  do  business  of  a  designated 
nature  to  the  requisite  number  of  persons  who  have 
complied  with  certain  requirements  of  the  statute 
laws  of  its  State.  A  legal  body  is  thus  created  that 
becomes  a  distinct  legal  entity,  separate  from  its 
stockholders.  This  legal  body  holds  property, 
makes  contracts,  and  does  all  other  acts  necessary  to 
carry  on  the  business  for  which  it  was  incorporated. 
When  it  is  incorporated  to  transport  persons  and 
property,  carrying  on  the  general  business  of  a  rail- 
road company,  the  State  gives  a  special  privilege  or 
franchise  to  operate  a  railroad,  which  other  corpora- 
tions do  not  have  by  mere  reason  of  their  incorpora- 
tion. This  franchise  to  operate  a  railroad  between 
certain  points  and  over  certain  territory  is  exclusive 
and  limited  to  this  corporation  to  which  it  is  granted. 
This  franchise  to  operate  a  railroad  is  property  and 
like  other  property  is  separable  from  the  corporation 
that  owns  it. 

The  question  of  the  power  of  the  railroad  com- 
pany to  execute  the  mortgage  is  passed  upon  by  well 
known  and  reputable  lawyers,  whose  written  opinion 


62  RAILROAD  BONDS  AND  NOTES 

usually  accompanies  the  mortgage.  This  opinion 
is  to  the  effect  that  the  railroad  company  has  been 
legally  organized,  that  it  had  legal  power  to  issue 
the  bonds  in  question,  and  also  the  mortgage  to  se- 
cure them,  that  such  bonds  have  been  legally  issued 
and  are  valid  obligations  of  the  railroad  company, 
and  that  the  mortgage  is  in  proper  form  to  entitle 
the  holders  of  the  bonds  to  the  protection  of  the 
security  pledged  by  it. 

Where  the  railroad  company  had  the  power  and 
authority  to  issue  the  bonds,  the  bondholders  are 
entitled  to  assume  that  all  the  requirements  of  its 
charter  and  the  laws  of  the  state  with  respect  to  the 
issuance  of  the  bonds  have  been  complied  with. 
This  ruling  has  been  made  necessary  by  a  considera- 
tion of  the  nature  of  railroad  bonds,  and  the  objects 
they  are  intended  to  serve,  for  it  would  defeat  their 
very  purpose  if  one  were  compelled  to  inquire  as 
to  these  facts  when  about  to  purchase  a  railroad 
bond  in  a  distant  State,  or  perhaps  a  foreign  coun- 
try, offered  for  sale  in  the  market. 

The  lien  that  the  mortgage  gives  the  bondholders ; 
liens  generally  discussed. 

The  mortgage  creates  a  lien  on  the  property  it 
covers  in  favor  of  the  trustee,  but  in  behalf  of  the 
holders  of  the  outstanding  securities  under  it  and 
for  their  benefit. 

By  a  lien  is  meant  that  the  property  to  which  it 


MORTGAGE  OR  DEED  OF  TRUST    63 

attaches  is  charged  with  a  special  obligation  to  those 
in  whose  favor  it  exists. 

The  effect  of  the  lien  of  the  mortgage  is  to  take 
the  property  against  which  the  mortgage  exists  and 
reserve  it  to  satisfy  in  full  the  bonds  and  coupons 
it  secures,  before  creditors  with  later  liens  against 
the  same  property  and  creditors  with  no  liens  re- 
ceive anything  out  of  it.  However,  all  claims  un- 
der liens  prior  in  point  of  time,  or  liens  superior  by 
reason  of  their  nature,  must  be  satisfied  in  full  out 
of  the  mortgaged  property  before  bondholders  re- 
ceive anything  under  their  mortgage. 

Liens  exist,  generally,  in  favor  of  recorded  mort- 
gages, taxes,  judgments,  etc. 

Liens,  generally  speaking,  have  priority  accord- 
ing to  the  time  they  attach  to  the  property,  except 
those  liens  which  by  reason  of  their  nature,  usually 
take  precedence  over  all  mortgages  or  other  liens 
without  regard  to  the  time  when  they  attached,  such 
as  liens  for  taxes  and  other  governmental  charges. 
See  Taxes,  Assessments,  Governmental  charges. 
Page  254.  The  courts  may,  also,  under  some  cir- 
cumstances, order  that  receiver's  certificates  and 
claims  for  "operating  expenses"  be  paid  out  of  the 
mortgaged  property  before  the  bonds  under  the 
mortgage  receive  anything  therefrom.  See  Receiv- 
er's certificates,  etc.  Page  2 1  o.  And  see  Operating 
expenses  prior  to  receivership.  Page  245. 

The  legal  effect  of  a  lien  against  railroad  property 


64  RAILROAD  BONDS  AND  NOTES 

is  determined  by  the  law  of  the  State  where  the 
property  is  located  upon  which  the  lien  is  sought  to 
be  enforced.  The  lien  of  the  mortgage  attaches 
when  the  mortgage  is  recorded  in  the  office  of  the 
public  official  designated  for  that  purpose  by  the 
law  of  the  State  where  the  property  is  situated. 
These  public  officers  are  either  the  clerk  or  the  reg- 
ister of  the  county  or  the  secretary  of  the  State  in 
which  the  property  is  situated.  The  lien  of  a  judg- 
ment attaches  to  the  property  of  the  road  from  the 
time  such  judgment  is  docketed  in  the  office  of  the 
clerk  of  the  county,  and  therefore  attaches  to  the 
property  of  the  road  situated  in  that  county.  A 
transcript  of  such  judgment  may  be  filed  in  other 
counties  of  the  State  and  thus  reach  the  property  in 
such  other  counties. 

Recording  the  mortgage. 

Recording  the  mortgage  means  that  it  is  copied 
at  length  in  books  kept  for  that  purpose  in  the  office 
of  the  public  official  charged  by  law  with  that  duty. 
It  is  then  a  public  record  and  all  may  examine  it. 

The  purpose  of  recording,  filing,  or  registering, 
the  mortgage,  as  these  acts  are  interchangeably 
called,  is  to  give  notice  to  all  persons  dealing  with 
the  property,  either  as  creditors  of  the  corporation 
or  as  purchasers  of  that  property,  that  it  is  charged 
with  certain  payments  and  obligations,  and  that  any 
rights  they  may  acquire  with  respect  to  that  prop- 


MORTGAGE  OR  DEED  OF  TRUST          65 

erty  must  be  subject  to  and  inferior  to  this  prior 
charge. 

In  some  States  there  are  statutes  which  provide  for 
a  special  manner  in  which  railroad  mortgages  may 
be  recorded. 

These  special  statutes  for  recording  are  usually 
to  the  effect  that  the  mortgage  shall  be  recorded  with 
a  State  official,  such  as  the  secretary  of  State,  and 
thereupon  the  lien  of  the  mortgage  shall  attach  to 
all  the  property  it  covers  located  in  that  State.  This 
dispenses  with  the  need  of  recording  the  mortgage 
in  each  county  of  the  State  in  which  the  property  is 
situated. 

Statutes  in  some  States  make  a  railroad  mortgage 
a  lien  on  the  property  it  covers  without  recording. 

Where  there  is  no  statute  for  special  recording, 
nor  for  making  it  a  lien  without  recording,  the  mort- 
gage must  be  recorded  in  the  office  of  the  public 
official  designated  by  law  for  that  purpose,  usually 
the  clerk  of  each  county  in  the  State  in  which  the 
mortgaged  property  is  situated.  To  facilitate  re- 
cording of  mortgages  where  the  property  is  situated 
in  several  counties  or  States,  a  number  of  originals 
are  executed  simultaneously,  all  being  recorded  as 
the  same  document.  They  are  duplicate  originals. 

Where  a  railroad  mortgage  covers  both  real  es- 
tate and  personal  property,  it  is  recorded  both  as 
a  real  estate  and  a  chattel  mortgage. 

Failure  to  record,  or  to  properly  record,  the  mort- 


66  RAILROAD  BONDS  AND  NOTES 

gage  does  not  affect  the  rights  of  the  bondholders 
and  their  trustee  in  the  mortgaged  property  so  far 
as  the  railroad  company  is  concerned;  but  as  to  third 
persons  a  situation  entirely  different  presents  itself. 
See  Defective  mortgages;  partly  defective.  Page 

67. 

Valid  bonds  as  affected  by  defective  mortgages; 
void  bonds. 

If  the  bonds  be  valid,  the  fact  that  the  mortgage 
given  to  secure  them  is  void  will  not  affect  them  in 
any  way. 

The  mortgage  affects  the  security  only  and  if 
void  will  deprive  the  bondholders  of  their  security. 
But  the  bonds  (the  obligation  of  the  issuing  com- 
pany to  pay)  will  remain  fully  valid  and  effective. 
The  invalidity  of  the  mortgage  will  not  taint  the 
bonds,  for  the  obligation  to  pay  the  debt  they  repre- 
sent continues ;  the  attempt  to  secure  them  has  failed. 
The  debt  remains  the  same  though  the  security  has 
been  lost. 

Where,  however,  the  bonds  are  void  the  mortgage 
though  executed  according  to  form  and  all  the  re- 
quirements, and  properly  recorded,  is  void. 

The  mortgage  is  given  to  secure  an  existing  in- 
debtedness represented  by  the  bond,  and  when  such 
debt  is  void  and  does  not  legally  exist,  there  is  no 
debt  to  secure,  and  the  attempt  to  mortgage  is  of 
no  effect. 


MORTGAGE  OR  DEED  OF  TRUST    67 

That  some  of  the  bonds  secured  by  the  mortgage 
are  invalid  does  not,  as  a  general  rule,  affect  the 
validity  of  the  mortgage  nor  any  legal  action  under 
it.  The  mortgage  continues  to  secure  those  bonds 
that  are  valid. 

Defective  mortgages;  partly  defective. 

Railroad  mortgages  executed  contrary  to  law  or 
without  power  are  void. 

A  railroad  mortgage  covering  several  parts  or  di- 
visions of  a  road  may  be  void  as  to  some  of  them 
and  valid  as  to  the  others. 

Should  the  mortgage  attempt  to  include  some 
property  that  the  railroad  company  had  no  power 
to  include,  the  mortgage  is  nevertheless  good  as  to 
the  property  it  had  authority  to  include,  though  void 
as  to  the  other. 

Synopsis  of  railroad  mortgage. 

The  following  is  a  synopsis  or  outline  of  the  usual 
form  of  railroad  mortgage.  It  contains  those  pro- 
visions commonly  found  in  railroad  mortgages  and, 
in  addition,  sinking  fund,  redeeming,  calling  in,  re- 
funding, and  conversion  into  capital  stock  of  the  rail- 
road company  arrangements,  besides  those  other  spe- 
cial provisions  that  the  particular  circumstances  of 
an  issue  may  require. 


68  RAILROAD  BONDS  AND  NOTES 

(a)  The  mortgage  recites  the  parties  to  it.     Pur- 
poses of  the  mortgage. 

The  parties  are  the  railroad  company  and  the  trus- 
tee. The  bondholders  are  not  made  parties  to  the 
mortgage  directly.  See  Reasons  for  trusteeship. 
Page  117. 

The  purposes  for  which  the  money  is  to  be  raised 
are  set  forth.  These  are  usually  to  transact  the  reg- 
ular business  of  the  corporation  and  to  exercise  its 
corporate  rights  and  privileges,  or  to  carry  out  any 
lawful  purpose  of  its  incorporation :  and  to  discharge 
underlying  liens,  when  the  issue  is  of  refunding 
bonds. 

(b)  Consents  of  stockholders,  directors,  public 
commissions  to  the  issue  of  bonds  and  the 
mortgage. 

The  consent  of  the  holders  of  the  requisite  propor- 
tion of  the  stock  of  the  railroad  company  to  the 
execution  of  the  mortgage  and  to  the  issuance  of  the 
bonds  is  then  stated  in  the  mortgage,  and,  too,  that 
at  a  special  meeting,  called  for  that  purpose,  the 
board  of  directors  approved  the  mortgage  and  passed 
its  resolution  that  the  railroad  company  execute  it. 

In  nearly  all  the  States  there  are  statutes  which 
provide  that  a  corporation  shall  not  execute  any 
mortgage  on  its  property  without  the  consent  of  the 
holders  of  a  specified  proportion  of  its  capital  stock. 
The  requisite  proportion  is  usually  two-thirds  of  the 


MORTGAGE  OR  DEED  OF  TRUST    69 

amount  of  its  outstanding  stock.  In  some  States 
the  consent  of  the  board  of  directors  is  also  necessary. 

Should  the  mortgage  be  executed  without  the 
requisite  consent  of  the  stockholders,  neither  the  rail- 
road company  nor  any  of  its  creditors  have  any 
standing  to  dispute  the  validity  of  the  mortgage  on 
this  account.  This  requirement  is  for  the  benefit 
and  protection  of  the  stockholders  and  can  be  taken 
advantage  of  only  by  them.  But  the  stockholders 
may  lose  their  right  to  object  to  a  mortgage  lacking 
this  consent,  by  their  unreasonable  delay  in  attack- 
ing it  or  by  permitting  the  railroad  company  to  ac- 
cept the  proceeds  under  it. 

Under  the  laws  of  most  of  the  States  a  statement, 
setting  forth  the  basis  or  financial  plan  upon  which 
the  bonds  are  to  be  issued,  must  be  submitted  to  a 
public  board  or  commission  which  must  approve  the 
issue  before  it  is  put  out.  A  recital  that  this  has 
been  done  is  invariably  included  in  the  mortgage. 

(c)  Amount  of  the  issue;  limitations;  protection 
against  over-issue;  closed  mortgages;  open- 
end  mortgages;  open  mortgages. 

The  amount  for  which  bonds  may  be  issued  by  a 
railroad  company  is  sometimes  limited  by  statute. 
These  statutes  are  usually  to  the  effect  that  the  total 
amount  of  the  outstanding  indebtedness  of  the  com- 
pany shall  not  exceed  a  certain  specified  proportion 
of  its  capital  stock  or  property. 


70  RAILROAD  BONDS  AND  NOTES 

Bonds  issued  in  excess  of  the  limitations  fixed  by 
statute  are  void. 

Where  the  railroad  company  issues  bonds  in  ex- 
cess of  the  amount  limited  in  the  mortgage,  but  not 
in  excess  of  the  amount  limited  by  a  statute,  such 
excess  issue  is  good  and  fully  enforceable  in  the  hands 
of  a  bona  fide  holder,  and  are  entitled  to  share  in 
the  security  with  the  other  bonds.  Excess  issues  are 
guarded  against  by  provisions  for  authenticating 
each  bond  by  a  certificate  of  the  trustee. 

The  mortgage,  therefore,  invariably  provides  that 
the  trustee  shall  authenticate  each  bond  by  en- 
dorsing or  attaching  his  certificate  to  the  effect  that 
such  bond  is  one  of  the  issue  secured  by  the  mort- 
gage, and  that  its  holder  is  entitled  to  the  benefits 
of  the  mortgage  and  of  the  trusteeship.  No  bond  is 
valid  for  any  purpose  where  such  a  provision  is  con- 
tained in  the  mortgage,  as  it  invariably  is,  without 
this  certificate  of  the  trustee.  Should  such  certifi- 
cate be  forged  the  bond  is  void  though  in  the  hands 
of  a  bona  fide  holder  for  value.  It  is  usually  pro- 
vided in  the  mortgage  that  the  bonds  shall  be  turned 
over  to  the  trustee  and  put  out  by  him  after  his 
certificate  has  been  endorsed  or  attached.  Some- 
times after  he  has  certified  to  the  bonds  the  trustee 
turns  them  over  to  the  railroad  company,  under  the 
terms  of  the  mortgage,  and  it  puts  them  out. 

The  aggregate  amount  of  the  issue  is  usually  speci- 


MORTGAGE  OR  DEED  OF  TRUST    71 

fied  and  limited  in  the  mortgage.  All  the  bonds  of 
the  issue,  however,  need  not  be  put  out  at  once. 

Where  the  money  is  raised  for  construction,  bonds 
for  a  specified  amount  are  usually  put  out,  from  time 
to  time,  as  the  work  progresses. 

Part  of  the  authorized  amount  of  an  issue  may 
be  reserved  to  retire  bonds  or  notes  or  underlying 
liens  soon  to  fall  due;  or  provision  may  be  made  to 
issue  a  fixed  amount  each  year,  or  at  some  other 
specified  time;  or  the  entire  amount  may  be  put  out 
at  once  or  in  such  amounts  and  at  such  times  as  the 
railroad  company  shall  require  for  its  business. 

When  the  aggregate  amount  of  the  issue  is  limited 
and  is  put  out  all  at  once  it  is  generally  called  a 
"closed  mortgage."  When  the  aggregate  amount  is 
limited  but  is  not  put  out  all  at  once,  but  from  time 
to  time,  at  specified  periods  or  on  certain  occasions, 
and  in  amounts  agreed  upon  in  the  mortgage,  it  is 
an  "open  end  mortgage."  The  amount  of  the  en- 
tire issue  secured  by  an  "open  end  mortgage"  is  lim- 
ited but  is  put  out,  from  time  to  time,  according  to 
the  terms  of  the  mortgage. 

The  "open  mortgage,"  so  called,  is  one  wherein 
there  is  no  limit  on  the  aggregate  amount  of  bonds 
that  may  be  issued  under  and  secured  by  it.  This 
kind  is  rare. 

The  favorite  form  of  mortgage  is  the  open  end 
mortgage  for  under  it  the  company  may  raise  money 


72  RAILROAD  BONDS  AND  NOTES 

for  present  requirements  and  anticipate  future  needs. 
See  General  mortgage  bonds;  blanket  mortgage 
bonds.  Page  269. 

(d)     Description  of  the  bonds  of  the  issue  to  be 
secured  by  the  mortgage. 

No.  $ 

United  States  of  America 

State  of 

The  Railroad  Company,  First  Mort- 

gage, Five  Per  Cent.,  Fifty  Years,  Refunding 
Gold  Bonds. 

The  Railroad  Company,  a  corporation  or- 

ganized and  existing  under  the  laws  of  the  State  of 
,  for  value  received,  hereby  agrees  to  pay  to 
bearer,  unless  this  bond  is  registered,  then  to  the 
registered  owner  thereof,  on  the  day  of  , 
19  ,  the  sum  of  dollars,  in  gold  coin  of  the 
United  States,  of  the  present  standard  of  weight 
and  fineness,  at  the  office  or  agency  of  the  Railway 
Company,  in  the  City  of  New  York,  together  with 
interest  thereon  at  the  rate  of  five  per  centum  per 
annum  from  day  of  ,  19  ,  payable  at 

the  same  place  in  like  gold  coin  on  the  days  of 

and  ,  in  each  year,  on  presentation 

and  surrender  of  the  annexed  coupons  as  they  sever- 
ally become  due. 

This  bond  is  one  of  a  series,  of  like  tenor  and  date, 
numbered  consecutively  from  one  upward,  issued 
and  to  be  issued  under  and  in  pursuance  of,  and  all 
equally  secured  without  priority  or  preference  by  a 
mortgage  or  deed  of  trust  to  the  Trust  Com- 


MORTGAGE  OR  DEED  OF  TRUST     73 

pany,  of  New  York,  bearing  even  date  herewith,  of 
all  the  line  of  railroad  of  said  Railroad  Company 
now  built  or  to  be  built,  and  the  franchises  author- 
izing the  construction  and  operation  thereof  now 
owned  or  hereafter  to  be  acquired,  as  therein  set 
forth. 

The  principal  of  this  bond  may  in  the  manner 
and  with  the  effect  prescribed  by  the  said  mortgage 
or  deed  of  trust,  be  declared  to  be  due  by  reason  of 
six  (6)  months'  default  in  the  payment  of  interest 
or  of  six  (6)  months'  default  in  the  performance  of 
any  other  obligation  imposed  by  the  said  mortgage 
or  deed  of  trust  on  the  said  Railroad  Company. 

No  recourse  shall  be  had  for  the  payment  of  the 
principal  or  interest  of  this  bond,  or  for  any  claim 
based  thereon  or  in  respect  thereof  or  of  said  mort- 
gage or  deed  of  trust,  against  any  stockholder,  offi- 
cer or  director  of  the  said  Railroad  Company, 
whether  by  virtue  of  any  statute  or  by  enforcement 
of  any  assessment  or  penalty  or  otherwise;  but  this 
provision  shall  not  be  held  to  exempt  any  officer  or 
director  from  liability  resulting  from  any  fraud  or 
wilful  neglect. 

Both  the  principal  and  interest  of  this  bond  are 
payable  without  deduction  for  any  tax  or  taxes  which 
the  Railroad  Company  may  be  required  to  pay  or 
retain  therefrom  under  any  present  or  future  laws 
of  the  United  States  of  America  or  of  any  State, 
county  or  municipality  therein,  said  Railroad  Com- 
pany hereby  agreeing  to  pay  all  such  tax  or  taxes. 

This  bond  may,  at  any  time,  upon  production 
thereof  to  the  said  Railroad  Company,  and  prior  en- 
dorsement being  made  thereon,  be  registered  in  the 
owner's  name  on  the  books  of  the  said  Railroad  Com- 


74  RAILROAD  BONDS  AND  NOTES 

pany.  After  such  registration,  no  transfer  of  the 
bond  shall  be  valid  unless  made  on  the  said  books  by 
the  registered  owner  in  person  or  by  his  attorney  duly 
authorized,  and  similarly  noted  on  the  bond.  This 
bond  may  be  discharged  from  registry  by  being  in 
like  manner  transferred  to  bearer  as  before.  The 
registration  of  this  bond  shall  not  affect  the  negoti- 
ability of  the  coupons,  which  shall  continue  to  be 
transferable  by  delivery. 

This  bond  shall  not  become  obligatory  until  the 
certificate  endorsed  hereon  is  signed  by  the  said 
trustee  or  its  successors  in  the  trust. 

(Note.  If  the  issue  is  for  refunding  purposes,  the 
statement  will  be  found  here  that  a  certain  propor- 
tion of  the  bonds  shall  be  issued  only  in  exchange, 
bond  for  bond,  for  the  underlying  issue  to  be  retired, 
under  the  conditions  described  in  the  mortgage;  or 
such  other  plan  of  refunding  as  the  mortgage  shall 
contain,  will  be  set  forth.  See  Refunding  plans. 
Page  .) 

(Note.  If  the  bonds  are  to  be  called  in  for  the 
sinking  fund,  the  provisions  therefor  are  included 
here.  See  Sinking  fund  arrangements.  Page  .) 

(Note.  If  the  railroad  company  reserves  the  right 
to  call  in  the  bonds  at  the  expiration  of  any  period, 
the  provisions  therefor  are  inserted  here,  with  the 
price  at  which  they  shall  be  called  in  or  redeemed. 
See  Redeeming  bonds;  Calling  bonds  in.  Page  .) 

(Note.  Provisions  for  converting  the  bond  into 
the  capital  stock  of  the  Railroad  Company  are  in- 
serted here,  if  that  be  one  of  the  features  of  the 
issue.  See  Provision  for  converting  bonds  into  cap- 
ital stock  of  the  railroad  company.  Page  .) 

(Note.     Should   the    Railroad   Company,    as   it 


MORTGAGE  OR  DEED  OF  TRUST          75 

usually  does,  waive  the  benefit  and  advantage  from 
any  and  all  stay,  extension,  redemption,  valuation  or 
appraisement  laws  then  or  thereafter  in  force,  a  pro- 
vision to  that  effect  is  inserted  in  the  bond.) 

In  Witness  Whereof,  the  Railroad  Com- 

pany has  caused  its  corporate  seal  to  be  hereunto 
affixed  and  the  same  to  be  attested  by  the  signatures 
of  its  President  and  Secretary  on  this  day  of 

,  191   . 

The  Railroad  Company, 

by 

Attest :  President. 

(Seal) 

Secretary. 

(Form  of  Coupon.) 
No.  $ 

The  Railroad  Company  will  pay  to  bearer, 

on  the  day  of  ,  19     ,  free  from  taxes, 

Dollars  in  United  States  Gold  Coin,  at  its  office  or 
agency,  in  the  City  of  New  York,  for  semi-annual 
interest,  on  its  First  Mortgage,  etc.,  Five  Per  Cent., 
Gold  Bond,  No.  ,  unless  the  said  bond  shall 
have  been  called  in  for  previous  redemption.  (See 
Redeeming  bonds;  Calling  bonds  in.  Page  98.) 

Treasurer. 

(Trustee's  Certificate.) 

This  is  one  of  a  series  of  bonds  described  in  the 
Mortgage  or  Deed  of  Trust,  referred  to  in  the  within 
bond.  (See  Amount  of  issue,  etc.;  protection 
against  over-issue,  etc.  Page  69.  Also  see  Trus- 
tee's certificate.  Page  70.) 

Trust  Company.     Trustee. 
by 

Vice-President. 


76  RAILROAD  BONDS  AND  NOTES 

(e)  Direct  obligation  of  the  railroad  (issuing) 
company;  stockholders,  officers  or  directors 
not  liable. 

The  issuing  company  promises  to  pay  the  princi- 
pal and  interest  of  the  bonds  according  to  their  terms 
and  tenor;  this  makes  it  the  direct  obligation  of  the 
issuing  company  as  distinguished  from  the  collateral 
obligation  of  a  guarantor.  By  the  direct  obligation 
is  meant  that  the  railroad  company  is  liable  to  pay  in 
the  first  instance,  that  it  owes  the  money  directly; 
by  the  collateral  obligation  is  meant  that  the  party 
is  liable  to  pay  only  when  the  one  directly  liable 
fails  to  do  so  as  in  the  case  of  one  company  guaran- 
teeing the  bonds  of  another. 

Many  mortgages  provide  that  no  recourse  shall 
be  had  for  the  payment  of  the  principal  or  interest 
of  the  bonds,  or  for  any  claim  based  on  them, 
against  any  stockholder,  officer  or  director  of  the 
railroad  company,  either  directly  or  through  the  com- 
pany. There  are  statutes  in  some  of  the  States  to 
the  effect  that  the  directors  and  sometimes  the  other 
officers  of  the  corporation  shall  file  annual  reports, 
and  for  their  failure  to  do  so,  certain  penalties,  such 
as  fines  or  other  liabilities,  are  imposed.  It  is 
against  such  and  similar  statutory  penalties  that  it 
is  thus  agreed  that  the  holders  of  the  bonds  or  cou- 
pons shall  not  have  recourse. 

However,  should  any  officer  or  director  act  fraud- 
ulently or  wilfully  neglect  his  duties,  and  the  bond- 


MORTGAGE  OR  DEED  OF  TRUST          77 

holder  be  injured  thereby,  he  may  then,  notwith- 
standing these  provisions,  have  his  action  against  the 
offending  officer  or  director.  And  the  fact  that  the 
bond  may  expressly  give  him  such  rights  adds  noth- 
ing as  he  has  this  remedy  without  the  provision  to 
that  effect. 

(£)     Property  is  transferred  to  the  trustee  to  se- 
cure the  bonds,  etc.,  upon  conditions,  etc. 

The  mortgage  conveys  to  the  trustee  the  property 
that  is  pledged  to  the  payment  of  the  issue.  A  de- 
tailed statement  of  the  property  is  set  forth  in  the 
mortgage. 

This  property  is  conveyed  to  the  trustee  absolutely, 
but  this  absolute  conveyance  is  later  qualified  in  the 
mortgage  by  a  provision  that  the  property  shall  be 
held  by  the  trustee  in  trust  and  upon  certain  condi- 
tions there  mentioned. 

This  trusteeship  thus  created  is  to  the  effect  that 
the  trustee  shall  hold  the  property  and  exercise  his 
rights  and  remedies  in  relation  thereto,  in  behalf  of 
the  bondholders  under  the  mortgage,  and  as  the  rail- 
road company  still  has  some  interests  in  the  prop- 
erty, with  due  regard  to  such  interests. 

The  conditions  upon  which  the  trustee  takes  the 
property  under  the  mortgage  are  that  if  the  railroad 
company  shall  pay  the  principal  and  interest  on  the 
bonds  and  perform  all  its  other  obligations  which  it 
has  assumed  under  the  terms  of  the  mortgage  and 


78  RAILROAD  BONDS  AND  NOTES 

the  bond,  then  the  conveyance  of  the  property  to 
the  trustee  falls  and  it  once  more  belongs  absolutely 
to  the  railroad  company. 

(g)  The  railroad  company  remains  in  possession 
of  the  mortgaged  road,  and  other  property, 
except  securities,  and  agrees  to  keep  same  in 
proper  condition,  etc. 

When  stocks,  bonds,  or  other  securities,  are  con- 
veyed by  the  mortgage  as  security,  they  are  delivered 
to  the  trustee;  he  holds  them  for  the  purposes  of  the 
trust  created  by  the  mortgage. 

The  voting  power  on  the  stocks  thus  deposited 
with  the  trustee  is  arranged  for  in  the  mortgage; 
the  disposition  of  the  dividends  on  such  stock  is  also 
provided  for  in  the  mortgage  as  is  also  the  interest 
on  such  bonds,  notes,  or  other  interest  bearing  se- 
curities that  have  been  thus  deposited. 

The  usual  provision  is  that  the  railroad  company 
shall  vote  the  deposited  stock  and  receive  all  divi- 
dends thereon,  and  the  interest  on  the  interest-bear- 
ing securities,  until  it  defaults  under  the  mortgage; 
that  after  it  defaults  the  trustee  shall  exercise  the 
voting  power  on  the  deposited  stock  and  shall  then 
also  receive  all  dividends  thereon,  and  also  the  inter- 
est on  the  interest-bearing  securities  that  have  been 
deposited. 

Where  real  estate  and  personal  property,  other 
than  securities,  are  conveyed  to  the  trustee  by  the 


MORTGAGE  OR  DEED  OF  TRUST    79 

mortgage,  it  is  usually  provided  that  the  railroad 
company  shall  continue  in  possession  and  use  the 
same  until  it  defaults  under  the  mortgage,  but  upon 
such  default  the  trustee  shall  be  entitled  to  physical 
possession  of  such  property  to  realize  on  it  for  the 
payment  of  the  sums  due  under  the  mortgage.  The 
railroad  company  is  also  granted  the  right  to  take 
and  to  use  the  income  of  the  road  during  the  time 
it  thus  operates  and  until  the  default. 

This  exemplifies  the  difference  between  the  ordi- 
nary pledge  and  mortgage.  In  the  case  of  a  pledge, 
the  property  passes  from  the  pledger  into  the  posses- 
sion of  the  pledgee,  to  be  held  by  him  until  the 
pledger  pays  the  money  due  or  performs  such  other 
acts  to  secure  which  the  property  has  been  pledged. 
Should  the  pledger  fail  to  pay  or  to  do  the  other 
acts  thus  secured,  then,  upon  his  default,  the  pledgee 
sells  the  property  and  reimburses  himself  out  of  the 
proceeds  for  any  loss  he  may  have  sustained. 
Should  the  pledger  pay  the  money  due  or  perform 
the  acts  required,  then  the  pledged  property  is  re- 
turned to  the  pledgor.  In  a  pledge  the  property 
must  actually  pass.  The  pledgee  must  have  actual 
possession.  Under  a  mortgage,  the  property  is  also 
charged  with  specified  obligations,  and  the  title  and 
possession  are  also  conveyed  to  the  mortgagee  (the 
trustee)  to  whom  the  property  is  pledged;  but  it  is 
invariably  provided  that  though  the  title  and  owner- 
ship of  the  property  thus  pass,  the  right  to  the  posses- 


8o  RAILROAD  BONDS  AND  NOTES 

sion  and  the  use  of  certain  property  shall  continue 
in  the  mortgagor  (the  railroad  company)  until  it 
defaults. 

A  mortgage  is  then  a  pledge  in  which  the  posses- 
sion does  not  pass  to  the  mortgagee;  it  is  a  dead 
pledge.  The  literal  meaning  of  the  word  "mort- 
gage" is  "dead  pledge."  The  word  is  derived  from 
the  French  words  "mort"  (dead)  and  "gage" 
(pledge). 

That  the  mortgaged  property  shall  not  lose  its 
value,  the  railroad  company  agrees  in  the  mortgage 
to  keep  the  property  in  good  repair,  and  as  part  of 
the  operating  expenses  of  the  road  to  make  all  neces- 
sary and  proper  improvements  and  betterments. 

It  is  quite  often  provided  that  when  a  certain  pro- 
portion (usually  about  one- third)  of  the  holders  of 
the  outstanding  bonds  shall  request  the  trustee  to 
demand  of  the  railroad  company,  that  the  railroad 
company  shall  thereupon  supply  a  report  from  its 
chief  engineer  as  to  the  physical  condition  of  its 
property  and  equipment;  or,  if  the  trustee  so  elects, 
he  may  have  such  property  and  equipment  examined 
by  an  engineer  of  his  own  selection.  Should  the 
mortgaged  property  and  equipment  upon  such  exam- 
ination be  shown  not  to  be  in  good  repair  and  condi- 
tion, then  the  railroad  company  shall  within  a  speci- 
fied time  (usually  ninety  days),  put  the  same  in  a 
proper  condition.  Failure  to  do  so,  it  is  usually  pro- 
vided, is  such  a  breach  of  the  mortgage  as  will  en- 


MORTGAGE  OR  DEED  OF  TRUST          81 

title  the  trustee  to  enter  into  possession  of  the  prop- 
erty and  sell  the  same,  or  to  foreclose  the  mortgage. 
If  the  railroad  company  were  merely  permitted  to 
use  the  property  as  it  was  at  the  time  of  the  giv- 
ing of  the  mortgage,  even  though  kept  in  good  re- 
pair, it  would  soon  deteriorate  unless  replaced  by 
new  parts  or  improved  along  the  lines  of  the  most 
recent  development  for  efficient  operation.  The 
railroad  company  is  therefore  permitted,  upon  the 
consent  of  the  trustee,  to  sell,  alter,  or  remove 
any  building,  fixtures,  machinery,  or  appliances, 
which  cannot  be  advantageously  used  in  the  judi- 
cious operation  and  management  of  the  road,  upon 
condition  that  it  shall  replace  the  property  so  sold 
or  removed  with  other  property  of  equal  value  and 
which  shall  immediately  become  subject  to  the  mort- 
gage; or  that  the  railroad  company  shall  pay  to  the 
trustee  the  appraised  value  of  such  property.  The 
trustee  holds  such  money  so  paid  him  for  the  se- 
curity of  the  bondholders  until  it  is  used  to  replace 
such  property ;  or  the  mortgage  may  provide  that  the 
trustee  shall  purchase  with  such  money  bonds  se- 
cured by  the  mortgage,  and  that  thereupon  these 
bonds  so  purchased  shall  be  canceled,  the  mortgage 
debt  thus  being  reduced  correspondingly  to  the  re- 
duction of  the  security. 

When  stocks,  bonds,  or  other  securities  are  de- 
posited with  the  trustee  under  the  mortgage,  it  is 
usually  provided  that  should  they  fall  below  the 


82  RAILROAD  BONDS  AND  NOTES 

value  at  which  they  were  accepted  as  security  under 
the  mortgage,  the  trustee  shall  demand,  and  upon 
such  demand  the  railroad  company  shall  replace 
them  by  others,  or  that  it  shall  deposit  additional 
securities  to  keep  the  aggregate  amount  of  deposited 
securities  at  the  value  at  which  they  were  originally 
accepted. 

(h)     Insurance  against  loss  by  fire,  etc. 

To  secure  such  of  the  mortgaged  property  from 
loss  as  is  liable  to  be  injured  or  destroyed  by  fire, 
the  railroad  company  agrees,  in  the  mortgage,  that 
it  will  insure  such  property  in  a  solvent  fire  insur- 
ance company  to  be  approved  by  the  trustees.  In 
case  of  loss,  payment  of  the  insurance  money  is  made 
to  the  trustee. 

The  trustee  holds  such  insurance  money  as  a 
substitute  for  the  property  that  has  been  destroyed 
or  damaged.  But  property  necessary  for  the  suc- 
cessful operation  of  the  road  cannot  be  dispensed 
with.  Insurance  money  in  the  hands  of  the  trus- 
tee held  at  the  expense  of  property  necessary  to 
maintain  the  road  interferes  with  the  productiv- 
ity of  the  road.  Railroad  mortgages,  therefore, 
quite  generally  provide  that  the  damaged  or  de- 
stroyed property,  when  feasible,  shall  be  repaired  or 
replaced  with  the  insurance  money.  The  railroad 
company  accordingly  proceeds  to  repair,  reconstruct 
or  replace  the  property,  injured  or  destroyed.  As 


MORTGAGE  OR  DEED  OF  TRUST          83 

this  work  progresses,  the  trustee  pays  over  to  the 
railroad  company,  from  time  to  time,  out  of  such 
insurance  money,  sums  equal  to  that  expended  by 
the  railroad  company  in  such  work,  when  such  ex- 
penditures represent  the  actual  value  of  the  work. 

(i)     Description  of  the  mortgaged  property. 

The  mortgage  must  specifically  mention  the  prop- 
erty it  pledges  as  security.  The  lien  of  the  mort- 
gage does  not  attach  to  any  property  that  is  not 
included  within  its  terms. 

The  usual  railroad  mortgage  conveys  the  land, 
rolling  stock,  property,  franchises,  rights  of  way,  all 
appurtenances,  buildings,  structures  and  improve- 
ments of  the  railroad  company.  And  when  stocks, 
bonds,  or  other  forms  of  securities  are  included  they 
are  set  forth  in  a  detailed  list.  The  mortgage  may 
also  contain  the  "after  acquired  property"  clause, 
by  which  it  is  intended  to  include  in  the  mortgage 
such  property  as  the  railroad  company  may  acquire 
at  any  future  time  during  the  life  of  the  mortgage. 

The  income  of  the  road  is  not  included  in  a  mort- 
gage by  implication;  to  include  it  it  must  be  spe- 
cifically mentioned. 

Should  income  be  included  in  a  mortgage,  the 
railroad  company  is  entitled  to  all  its  income  while 
in  control  and  operation  of  the  road.  It  is  entitled 
to  these  moneys,  notwithstanding  that  they  are  in- 
cluded in  the  mortgage,  until  it  defaults  under  some 


84  RAILROAD  BONDS  AND  NOTES 

of  the  terms  of  the  mortgage  and  the  receiver  takes 
possession  under  order  of  the  court  or  the  trustee 
demands  possession  under  the  mortgage.  This  is 
the  law  in  the  absence  of  any  agreement  to  the  con- 
trary. The  mortgage  may,  though  it  is  unusual, 
contain  a  provision  that  the  income,  earnings,  and 
profits  received  by  the  railroad  company  while  it  is 
in  possession  and  operates  the  road,  shall  be  consid- 
ered as  held  by  it  in  trust  for  the  bondholders. 

Any  income  included  in  a  mortgage  is  held  to 
mean  net  income;  that  is,  the  income  after  all  ex- 
penses necessary  to  produce  it  have  been  deducted. 

Income  only  is  sometimes  mortgaged  for  the  pay- 
ment of  the  interest  only  of  an  issue  of  bonds.  This 
is  in  the  case  of  income  bonds,  where  the  payment 
of  the  interest  of  the  bonds  is  dependent  upon  the 
fact  that  the  income  has  been  earned  during  that 
interest  period.  See  Income  bonds,  etc.  Page  329. 
The  mortgage  by  a  railroad  company  of  "all  its 
right,  title  and  interest"  in  the  rolling  stock  and 
equipment  used  by  it,  as  is  sometimes  done,  suggests 
the  inquiry  as  to  what  right,  title  and  interest  it  has 
in  such  rolling  stock  or  equipment;  whether  or  not 
it  owns  it  and  what  liens  it  is  subject  to;  or  if  it  is 
being  used  under  a  lease  or  car  trust  arrangement. 
See  Car  trust  certificates  or  bonds.  Page  31 6.  Also 
see  Equipment  trust  certificates  or  bonds.  Page 
316. 


MORTGAGE  OR  DEED  OF  TRUST    85 

(j)     After  acquired  property, 

In  addition  to  such  property  as  is  specifically 
named  in  the  mortgage  and  which  the  railroad  com- 
pany owns  at  the  time  the  mortgage  is  executed, 
there  may  be  included  also  such  property  as  the  com- 
pany might  acquire  at  some  future  time  during  the 
life  of  the  mortgage. 

The  lien  of  the  mortgage  attaches  to  such  after 
acquired  property  whenever  the  railroad  company 
acquires  it. 

The  intention  of  the  after  acquired  property  clause 
in  railroad  mortgages  is  usually  to  impress  the  lien 
of  the  mortgages  upon  such  property  as  may  be  sub- 
stituted or  added  to  equip  the  road  with  modern 
appliances  as  well  as  to  replace  worn  out  parts  with 
new  material. 

This  clause,  however,  may  be  construed  to  cover 
all  property  that  the  railroad  company  might  ac- 
quire at  any  future  time  during  the  life  of  the  mort- 
gage, that  is,  property  of  a  different  nature  and 
under  different  circumstances  than  just  mentioned. 
How  far  reaching  an  effect  the  courts  will  give  to 
this  clause  depends  upon  its  language. 

The  lien  of  the  after  acquired  property  clause, 
under  all  circumstances,  attaches  to  the  after  ac- 
quired property  in  the  condition  that  it  comes  into 
the  possession  of  the  railroad  company.  If  there 
are  any  mortgages  or  other  liens  against  it  at  the 


86  RAILROAD  BONDS  AND  NOTES 

time  the  railroad  company  receives  it,  they  take 
precedence  and  priority  over  the  lien  of  the  mort- 
gage containing  the  after  acquired  property  clause. 

Railroad  mortgages  have  the  tendency  not  to  in- 
clude the  after  acquired  property  clause ;  at  any  rate 
not  to  have  one  that  is  so  broad  that  it  may  em- 
barrass, if  not  prevent,  it  from  acquiring  a  branch 
line  or  an  extension,  or  other  property,  when  it  was 
not  really  the  intention  that  property  of  this  kind 
should  be  included  in  the  mortgage. 

But  this  embarrassment  is  sought  to  be  avoided, 
when  property  of  the  kind  just  mentioned  is  ac- 
quired and  the  after  acquired  property  clause  is 
broad  enough  to  include  it,  by  taking  such  prop- 
erty subject  to  as  large  a  purchase  money  mortgage 
as  possible;  or  by  leasing  instead  of  purchasing  it; 
or,  when  the  property  is  rolling  stock,  by  taking  it 
under  the  "car  trust"  arrangement;  or,  when  it  is  a 
branch  line  or  extension,  by  incorporating  a  separate 
company  and  taking  the  property  in  the  name  of 
such  new  corporation,  organized  for  that  purpose 
only.  Rolling  stock  and  equipment  is  also  some- 
times taken  under  this  plan  of  a  separate  corpora- 
tion holding  the  title  to  it. 

(k)     The  railroad  company  agrees  to  preserve  the 
lien  of  the  mortgage. 

The  railroad  company  also  agrees  in  its  mortgage 
that  it  will  pay  all  taxes,  water  rates,  assessments, 


MORTGAGE  OR  DEED  OF  TRUST    87 

and  governmental  charges  lawfully  imposed  on  the 
property. 

Taxes,  and  charges  of  that  character,  are  a  lien 
against  the  property  of  the  road  superior  and  prior 
to  all  mortgages,  no  matter  when  they  accrued. 

The  company,  therefore,  agrees  to  discharge  all 
such  claims,  and  also  such  other  claims,  the  lien  of 
which  might  be  given  a  preference  over  the  lien  of 
the  mortgage.  Under  this  heading,  and  contem- 
plated by  such  a  provision,  are  claims  for  operating 
expenses  and  other  indebtednesses  entitled  by  law  to 
a  preference.  See  Operating  expenses  prior  to  re- 
ceivership. Page  245. 

The  failure  of  the  railroad  company  to  discharge 
liens  and  claims  of  this  nature  would  result  in  hav- 
ing the  standing  of  the  mortgage  displaced  in  favor 
of  such  preferred  liens  and  claims,  and  thus  the 
priority  that  the  bondholders  enjoyed  and  were  en- 
titled to  would  be  lost  to  them.  The  railroad  com- 
pany obligates  itself,  therefore,  to  pay  all  claims 
of  this  kind  before  they  fall  in  arrears  so  that  the 
standing  and  lien  of  the  mortgage  shall  be  preserved. 

It  is  usually  provided,  however,  that  the  railroad 
company  shall  not  be  required  to  pay  such  taxes, 
assessments,  or  other  claims  entitled  to  a  preference 
over  the  mortgage,  so  long  as  it  shall  in  good  faith 
contest  their  validity.  And  a  failure  to  pay  such 
claims  will  not  be  construed  as  a  default  if  the  com- 
pany is  contesting  them  in  good  faith. 


88  RAILROAD  BONDS  AND  NOTES 

(1)  Execution  of  all  papers  necessary  to  facilitate 
the  trust;  waiving  redemption  and  exemption 
laws. 

The  railroad  company  always  agrees  in  its  mort- 
gage that  it  will  execute  and  deliver  to  the  trustee 
any  legal  instruments  or  documents  that  may,  after 
the  mortgage  is  executed,  be  necessary  to  carry  out 
the  purposes  of  the  trusteeship.  This  is  to  insure 
full  power  and  title  in  the  trustee  to  proceed  in  be- 
half of  his  bondholders  in  any  matter  that  may  arise 
under  the  mortgage. 

Should  the  title  as  conveyed  to  the  trustee  by  the 
mortgage  be  questioned  at  any  time,  the  court  will 
compel  the  railroad  company  to  execute  all  legal 
instruments  needed  to  vest  in  the  trustee  such  title 
as  may  be  necessary  for  him  to  fully  protect  the 
rights  of  his  bondholders  under  the  mortgage  and 
to  carry  out  his  trusteeship. 

And  to  further  facilitate  the  trustee  in  pur- 
suing his  remedies,  the  railroad  company  usually 
agrees  in  its  mortgage  not  to  apply  for  or  avail 
itself  of  any  appraisement,  valuation,  stay,  exten- 
sion, exemption  or  redemption  laws  that  may  prevent 
or  interfere  with  the  entry  of  the  trustee  into  posses- 
sion and  his  operation  of  the  road  or  his  proceeding 
to  foreclose  the  mortgage,  and  expressly  waives  the 
benefits  of  such  laws. 

And  as  a  further  aid  in  the  enforcement  of  the 
security  afforded  by  the  mortgage,  the  railroad  com- 


MORTGAGE  OR  DEED  OF  TRUST          89 

pany  consents,  so  far  as  it  can,  to  the  appointment 
of  a  receiver,  when  the  trustee  applies  to  the  court 
for  a  receivership.  And  it  further  consents,  usually, 
that  the  trustee  shall  receive  the  income  of  the  mort- 
gaged premises  and  property  during  such  legal  pro- 
ceedings. 

(m)     Rights,  remedies,  powers  and  liabilities  of 
the  trustee,  etc. ;  trustee's  certificate. 

Throughout  the  railroad  mortgage,  certain  rights 
and  remedies  are  conferred,  and  certain  duties  are 
imposed  on  the  trustee  in  favor  of  the  bondholders; 
and  he  is  there  given  power  to  perform  certain  acts 
for  their  protection  which  the  law  does  not  ordi- 
narily give  him.  Apart  from  what  the  bond  or  the 
mortgage  may  say  in  this  respect,  the  law  imposes 
on  the  trustee  certain  duties  growing  out  of  the  trust 
relation  that  exists  between  him  and  the  bondhold- 
ers. 

It  is  the  duty  of  the  trustee  to  protect  his  bond- 
holders and  realize  on  the  security  for  them.  Ac- 
cordingly, he  must  proceed  at  once  to  enforce  the 
remedies  that  the  law  and  the  mortgage  give  him  to 
protect  the  rights  of  his  bondholders.  But  the  mort- 
gage usually  modifies  immediate  action  by  providing 
that  the  trustee  shall  proceed  with  regard  to  cer- 
tain remedies  only  when  requested  to  do  so  by  the 
holders  of  a  certain  proportion  of  the  bonds  then 
outstanding,  or  that  he  need  not  proceed  until  he 


90  RAILROAD  BONDS  AND  NOTES 

has  been  properly  indemnified  against  any  loss  he 
might  sustain  or  liability  he  might  incur  in  carry- 
ing out  any  of  these  special  remedies  in  behalf  of 
the  bondholders. 

To  protect  the  holders  of  an  issue  of  bonds  against 
an  over-issue,  or  a  fraudulent  issue,  the  mortgage 
provides  that  the  trustee  shall  authenticate  each  bond 
of  the  issue  with  his  certificate;  any  bond  issued 
without  such  certificate  is  void  and  is  not  entitled 
to  the  benefits  of  the  mortgage  securing  the  issue. 
Such  bond  *cannot  be  enforced.  Should  the  trus- 
tee's certificate  be  forged  the  bond  is  void  and  not 
entitled  to  the  benefits  of  the  mortgage.  For  form 
of  trustee's  certificate  see  Page  75. 

After  he  certifies  them  the  trustee  may  put  out 
the  bonds  himself;  or  he  may  return  them,  after 
certification,  to  the  railroad  company  to  be  put  out 
by  it.  He  may  put  them  out  or  turn  them  over  to 
the  railroad  company,  as  the  case  may  be,  all  at 
once,  or  in  certain  portions  or  allotments,  at  such 
times  and  in  such  quantities  or  amounts  as  the  mort- 
gage shall  provide. 

The  rights  and  remedies  of  the  trustee  under  the 
mortgage  and  under  the  law,  with  the  duties  and 
obligations  growing  out  of  his  trusteeship,  due  to 
the  very  nature  of  that  relationship,  are  more 
fully  discussed  in  the  next  chapter.  See  Chapter 
IV.  Rights  and  Remedies  with  Relation  to  the 
Trusteeship.  Page  116. 


MORTGAGE  OR  DEED  OF  TRUST    91 

(n)     Provisions  as  to  payment  of  principal  and 
interest;  free  from  all  taxes;  gold  coin. 

The  railroad  company  agrees  in  the  bond  and  the 
mortgage  to  pay  each  instalment  of  interest,  and  the 
principal  of  the  bond,  and  each  instalment  of  prin- 
cipal, when  they  respectively  fall  due. 

It  also  usually  agrees  to  pay  these  sums  without 
reduction  from  principal  or  interest  for  any  taxes, 
assessments  and  governmental  charges  that  may  be 
imposed  upon  the  bond  or  the  interest,  which  the 
company  may  be  required  to  deduct  therefrom. 
This  provision  includes  payments  under  the  income 
tax  law.  The  holder  of  the  bond  or  coupon,  as  the 
case  may  be,  receives  his  interest  in  full  without  any 
deduction  for  the  tax,  the  railroad  company,  being 
liable  therefor,  makes  the  payment  to  the  govern- 
ment officials. 

In  the  absence  of  any  provision  to  the  contrary, 
immediately  upon  the  default  of  the  railroad  com- 
pany in  the  payment  of  any  instalment  of  interest, 
or  of  an  instalment  of  principal,  or  the  perform- 
ance of  any  of  its  obligations  under  the  mortgage, 
the  railroad  company  is  in  default  and  the  remedies 
that  the  trustee  has  at  his  command  may  be  enforced 
against  the  mortgaged  road  and  property.  See 
What  constitutes  a  default.  Page  148.  In  the  so- 
called  "Gold  Bonds"  the  issuing  company  agrees 
in  its  bond  and  mortgage  to  pay  the  bonds  and  in- 
terest or  the  coupons,  in  the  case  of  coupon  bonds, 


92  RAILROAD  BONDS  AND  NOTES 

in  gold  coin  of  the  United  States  of  America,  of  or 
equal  to  the  standard  of  weight  and  fineness  at  the 
time  of  the  issue.  The  holder  may  then  insist  upon 
such  payment. 

(o)     Priorities,  if  any,  between  principal  and  in- 
terest; canceling  paid  coupons. 

It  is  usually  provided  in  railroad  mortgages  that 
they  shall  secure  the  payment  of  the  principal  and 
the  interest  of  all  the  bonds  issued  under  it,  without 
preference  or  priority,  and  equally  and  ratably. 
However,  a  different  arrangement  may  be  made  in 
distributing  the  proceeds  of  the  mortgaged  property, 
and  interest  may  be  preferred  in  payment  over  prin- 
cipal; or  the  different  instalments  of  interest  may 
be  preferred  in  payment  according  to  the  dates  on 
which  they  respectively  fell  due;  or  some  other  ar- 
rangement may  be  properly  included  in  the  mort- 
gage. See  also  Priorities  between  interest  coupons 
and  claims  for  interest.  Page  260. 

Where  there  is  nothing  said  in  a  mortgage  about 
priority,  all  claims  under  it  for  principal  and  inter- 
est share  proportionately. 

Railroad  mortgages  usually  provide  that  when  the 
interest  coupons  are  paid  they  shall  be  surrendered 
and  canceled.  Should  paid  coupons  be  allowed  to 
remain  uncanceled,  there  is  danger  that  they  may 
be  negotiated  again  and  their  holder  seek  the  pro- 
tection of  the  security  in  conflict  with  the  holders 


MORTGAGE  OR  DEED  OF  TRUST    93 

of  the  unpaid  coupons  and  the  bonds.  The  coupons 
are  either  paid  by  the  trustee  or  under  his  supervi- 
sion; and  he  protects  the  bondholders  by  seeing  that 
such  paid  coupons  are  canceled.  The  provision  is 
also  added  in  the  mortgage  that  all  coupons  matur- 
ing before  the  delivery  of  the  bonds  shall  be  cut 
off  and  canceled  before  such  bonds  shall  be  put 
out. 

(p)     Sinking  fund  arrangement. 

The  sinking  fund  arrangements  that  are  included 
in  railroad  mortgages  vary  according  to  the  objects 
that  are  to  be  attained.  The  basic  idea  of  all  sink- 
ing funds  plans  is  to  set  aside  a  specified  sum 
periodically,  annually  or  semi-annually,  and  with  it 
to  buy  in  the  bonds  of  the  issue  at  stated  periods, 
and  thus  reduce  the  bonded  indebtedness  gradually; 
or  to  save  up,  as  it  were,  to  meet  the  entire  issue  at 
maturity,  in  the  meantime  investing  the  fund  so 
accumulated. 

The  trustee  owes  the  active  duty  to  the  bond- 
holders to  see  that  the  railroad  company  faithfully 
carries  out  the  sinking  fund  arrangement. 

The  details  of  the  particular  plan  used  are  set 
forth  in  the  mortgage. 

A  common  method  that  railroad  companies  em- 
ploy to  create  and  maintain  the  sinking  fund  is 
that  by  which  it  agrees  to  turn  over  to  the  trustee  at 
designated  times  (usually  annually  or  semi-an- 


94  RAILROAD  BONDS  AND  NOTES 

nually)  either  a  fixed  sum;  or  a  certain  proportion 
of  its  gross  earnings  or  net  income,  or  other  specified 
source  of  income  or  revenue;  or  an  amount  equal  to 
a  specified  proportion  of  the  amount  of  the  out- 
standing bonds. 

If  the  plan  is  to  meet  the  entire  issue  at  maturity, 
the  trustee  usually  takes  the  money  so  received  from 
the  railroad  company,  and  invests  it  in  interest  bear- 
ing securities.  With  the  interest  from  these  invest- 
ments, the  arrangement  may  provide  that  he  shall 
pay  the  interest  on  the  bonds,  or,  the  provision  may 
be  that  the  railroad  company  shall  pay  the  interest; 
or  the  plan  may  provide  that  the  trustee  shall  re- 
invest such  interest  as  he  shall  receive,  from  time 
to  time,  and  accumulate  the  same  which  also  shall 
be  used  to  meet  the  bonds  at  maturity. 

The  trustee  must  watch  the  securities  in  which  the 
sinking  fund  is  invested,  and  when  any  depreciates 
appreciably  in  value,  he  must  see  that  it  is  replaced. 

The  arrangement  may  be  that  by  which  bonds  of 
the  issue  are  called  in  periodically,  the  trustee  then 
buys  them  up  with  the  moneys  so  received  for  that 
purpose;  and  after  purchase  usually  holds  them  as 
against  the  railroad  company  as  if  they  had  not  been 
paid  off.  The  bonds  thus  purchased  and  held  by 
the  trustee  continue  to  draw  interest;  this  interest 
is  received  by  the  trustee  and  used  by  him  to  buy 
in  more  bonds  for  the  sinking  fund.  The  mortgage 


MORTGAGE  OR  DEED  OF  TRUST    95 

continues  to  secure  such  bonds  so  purchased  and  held 
by  the  trustee. 

A  failure  on  the  part  of  the  railroad  company  to 
maintain  the  sinking  fund  according  to  the  terms  of 
the  mortgage  is  a  default  and  entitles  the  trustee 
to  enforce  the  mortgage.  A  provision  may  be  con- 
tained in  the  mortgage,  and  it  usually  is,  that  a  de- 
fault of  this  kind  shall  continue  for  six  months  be- 
fore action  shall  be  taken  on  it. 

When  the  sinking  fund  arrangement  or  plan  is 
that  a  specified  proportion  of  the  bonds  shall  be  paid 
off  at  designated  periods,  until  the  entire  issue  has 
been  gradually  retired,  the  question  presents  itself: 
Which  bonds  shall  be  paid  off?  The  course  usually 
pursued,  and  the  plan  that  most  railroad  mortgages 
contain,  is  that  the  trustee  shall  buy  the  specified 
number  or  proportion  of  the  bonds  in  the  open  mar- 
ket at  a  price  not  to  exceed  that  fixed  in  the  mort- 
gage; but  before  buying  in  the  open  market  the 
trustee  must,  under  the  terms  of  such  plan,  give  the 
bondholders  of  that  issue  a  reasonable  opportunity 
to  first  offer  their  bonds  to  him.  He  notifies  the 
bondholders  by  advertisement  in  the  newspapers, 
that  he  has  received  a  certain  sum  for  the  sinking 
fund  to  purchase  the  bonds  at  a  price  not  to  exceed 
the  price  mentioned  in  the  mortgage  and  invites 
them  to  present  their  bids  on  or  before  a  designated 
date.  Such  bid  must  specify  the  price  at  which 


96  RAILROAD  BONDS  AND  NOTES 

the  holder  will  sell.  The  trustee  reserves  the  right 
to  reject  any  part  of  the  offer  should  more  be  ten- 
dered than  there  is  money. 

When  the  bids  are  opened,  the  bonds  offered  at 
the  lowest  price  are  accepted  and  such  bonds  are 
paid  off  and  held  by  the  trustee  under  the  terms  of 
the  sinking  fund  plan. 

If  the  trustee  cannot  buy  at  the  price  the  mort- 
gage limits  him  to,  neither  in  the  open  market  nor 
through  advertising,  then  he  shall  call  in  and  pay 
off  the  necessary  number  or  amount  or  proportion 
of  bonds  and  pay  them  the  amount  or  price  stipu- 
lated in  the  mortgage.  He  calls  them  in  by  draw- 
ing by  lot. 

The  manner  of  drawing  is  fixed  in  the  mortgage. 
It  usually  takes  place  at  the  office  of  the  trustee; 
though  another  place  may  be  designated. 

Bondholders  are  entitled  to  receive  notice  of  what 
bonds  have  been  called  in  for  the  sinking  fund. 
Such  notice  is  usually  given  by  the  trustee  at  the 
expense  of  the  railroad  company,  by  advertising  in 
newspapers  of  general  circulation  in  a  city  of  recog- 
nized importance  as  a  money  center.  Such  notice  is 
also  published  in  newspapers  in  the  city  where  the 
railroad  company  has  its  principal  office. 

The  notice  is  usually  published  once  a  week  for 
a  few  consecutive  weeks.  It  states  the  numbers  of 
the  bonds  that  have  been  drawn  for  the  sinking  fund 
and  retirement,  and  thus  identifies  them.  If  any  of 


MORTGAGE  OR  DEED  OF  TRUST     97 

the  drawn  bonds  be  registered,  the  registered  owner 
is  entitled  to  a  similar  notice  to  be  mailed  to  his 
address  as  given  on  the  registry  books,  within  a  rea- 
sonable time  prior  to  the  date  fixed  for  its  retire- 
ment. 

The  effect  of  having  a  bond  drawn  for  the  sink- 
ing fund  is  that  the  holder  of  such  bond  must  sur- 
render it,  with  all  coupons  maturing  after  that  date, 
to  the  trustee  for  purchase  by  him  at  the  price  agreed 
upon  in  the  mortgage.  Should  the  bonds  be  regis- 
tered they  must  be  surrendered  with  a  proper  assign- 
ment in  writing. 

The  bonds  are  called  in  on  an  interest  day  as  an 
invariable  rule.  And  the  holder  upon  surrender  re- 
ceives the  price  agreed  upon  plus  the  interest  to  that 
date. 

Should  the  holder  not  surrender  his  bond  when 
drawn  for  the  sinking  fund,  whether  wilfully  or 
through  lack  of  notice  or  knowledge,  he  loses  his 
right  to  interest  from  the  date  specified  for  its  re- 
tirement. The  bond  will  not  bear  interest  after  that 
date  and  all  coupons  for  future  interest  are  void. 
The  bond  itself,  however,  continues,  so  far  as  its 
principal  is  concerned,  as  a  valid  obligation  of  the 
issuing  company  and  it  is  not  affected  by  the  fact 
that  it  was  drawn  for  the  sinking  fund;  except  that 
sometimes  it  is  stipulated  in  the  mortgage  that  the 
bond  so  drawn  for  the  sinking  fund  and  not  surren- 
dered shall  no  longer  be  entitled  to  the  benefit  of 


98  RAILROAD  BONDS  AND  NOTES 

the  security  of  the  mortgage  and  its  sinking  fund 
after  the  date  it  should  have  been  surrendered. 

The  sinking  fund  arrangement  by  which  the  bonds 
may  be  regarded  as  additionally  secured  does  not 
preclude  the  trustee  or  the  bondholders  from  their 
other  remedies,  nor  interfere  with  their  other  rights 
and  remedies  in  any  way. 

The  wisdom  of  the  sinking  fund  which  takes 
periodically  from  the  working  capital  of  a  railroad 
large  sums  has  been  questioned.  The  sinking  fund, 
however,  is  absolutely  needed  to  meet  the  bonds  of 
corporations  working  mines,  timber  lands,  or  other 
enterprises  in  which  the  assets  are  being  constantly 
depleted.  The  property  of  a  railroad  company  in 
good  standing  is,  as  a  rule,  being  constantly  improved 
and  in  the  course  of  time  should  afford  a  better 
security. 

(q)     Redeeming  bonds  or  calling  bonds  in. 

Sometimes  the  railroad  company  has  the  right,  un- 
der the  terms  of  its  mortgage,  to  call  in  and  pay  off 
all  or  any  portion  of  the  outstanding  issue  at  its  own 
option. 

The  period  within  which  it  may  do  so  is  then 
specified.  Bonds  that  are  payable  "30-50"  years 
typify  this.  In  such  an  issue  the  bonds  may  be 
called  in  at  any  time  from  after  thirty  years  from  the 
date  of  issue  to  the  time  of  maturity.  The  price 


MORTGAGE  OR  DEED  OF  TRUST    99 

that  must  be  paid  on  calling  in  the  bond  is  fixed  in 
the  mortgage. 

The  holders  of  the  bonds  are  entitled  to  a  reason- 
able notice  of  the  intention  of  the  railroad  company 
to  exercise  this  option  to  redeem,  to  call  in,  or  to  pay 
off  their  bonds.  The  mortgage  sets  out  in  detail  all 
the  requirements  of  the  notice  and  how  and  when 
it  shall  be  served.  Usually  one  to  six  months'  no- 
tice is  given  by  advertisements  in  the  newspapers. 

The  notice  advises  the  bondholders  that  the  rail- 
road company  has  elected  to  and  will  redeem  cer- 
tain outstanding  bonds,  describing  them,  on  a  speci- 
fied date,  at  the  price  agreed  upon  in  the  mortgage, 
with  accrued  interest. 

The  bonds  are  usually  to  be  presented  and  paid  off 
at  the  office  of  the  trustee,  though  another  place  may 
be  designated.  After  the  date  fixed  for  such  redeem- 
ing, they  will  cease  to  draw  interest  and  the  coupons 
for  interest  accruing  subsequent  to  that  date  will  be 
void. 

It  is  sometimes  stipulated  in  the  mortgage  that 
after  the  date  fixed  for  their  redemption,  the  bonds 
shall  cease  to  be  entitled  to  the  protection  of  the  se- 
curity of  the  mortgage.  Though  the  security  of  the 
bonds  may  be  thus  taken  from  them  by  agreement, 
they  continue  as  valid  obligations  of  the  issuing  com- 
pany, which  continues  liable  for  the  principal  though 
the  interest  thereon  may  be  lost  from  the  date  fixed 


ioo          RAILROAD  BONDS  AND  NOTES 

for  redemption.  Payment  or  accepting  other  securi- 
ties in  their  place,  or  some  other  kind  of  satisfaction 
alone  can  discharge  them. 

However,  if  the  bonds  and  their  coupons  are  prop- 
erly presented  at  the  time  and  at  the  place  fixed  for 
their  redemption  and  payment,  and  they  are  not  paid 
according  to  the  terms  of  the  mortgage,  then  the  inter- 
est and  the  coupons  continue  as  theretofore,  and  the 
bonds  and  their  interest  continue  to  be  secured  and 
protected  by  the  mortgage. 

(r)     Payment   of  serial  bonds;   bonds  issued   in 
series. 

The  uncertainty  as  to  when  a  railroad  bond  may 
be  called  in  for  sinking  fund  purposes,  or  redeemed 
by  the  railroad  company,  with  possible  loss  of  inter- 
est and  security,  has  been  considered  an  objection. 
To  overcome  this  the  serial  bond  is  employed. 
These  bonds  are  like  other  bonds  except  that  they  are 
numbered  consecutively,  or  divided  into  classes 
designated  by  letters.  At  a  fixed  time  the  bonds  of 
the  issue  of  a  specified  lettered  class,  or  those  within 
certain  numbers,  fall  due  and  are  paid.  The  price 
that  shall  be  paid  for  them  is  fixed  in  the  mortgage. 
Under  this  arrangement  the  holder  has  the  advantage 
of  knowing  just  when  his  bond  will  mature. 

Serial  bonds,  just  discussed,  are  to  be  distinguished 
from  bonds  issued  in  series.  A  mortgage  may  secure 
an  issue  of  bonds  in  an  aggregate  limited  amount, 


MORTGAGE  OR  DEED  OF  TRUST         101 

and  provide  that  they  shall  be  put  out  in  series  of 
specified  amounts,  from  time  to  time,  at  fixed  periods, 
or  as  the  needs  of  the  railroad  company  shall  require, 
or  upon  the  happening  of  a  certain  event,  or  upon 
some  mentioned  condition,  as  the  case  may  be.  All 
bonds  of  such  an  issue  fall  due  upon  the  same  day  no 
matter  when  issued  or  put  out.  They  are  merely  put 
out  and  sold  in  series.  This  is  the  practice  in  the 
case  of  a  large  issue,  usually  under  a  general  mort- 
gage or  blanket  mortgage.  The  proceeds  of  a  series, 
or  part  of  such  an  issue,  is  used  usually  to  retire  un- 
derlying liens  and  so  to  clear  the  way  to  strengthen 
the  lien  of  the  general  or  blanket  mortgage ;  the  pro- 
ceeds of  another  series  may  be  used  to  provide  for 
present  needs  of  the  road ;  and  the  balance  furnishes 
the  ready  means  to  raise  money  in  the  future,  without 
the  trouble  and  expense,  and  possible  adverse  market 
conditions,  of  other  issues  at  each  time  such  money 
may  be  required.  The  entire  issue  is  secured  by  the 
mortgage. 

(s)     Refunding  plans. 

The  refunding  mortgage  will  contain  the  plan 
whereby  part  of  the  money  to  be  raised  (though  the 
entire  amount  of  the  issue  may  be  devoted  to  that 
purpose)  shall  be  used  to  take  up  some  prior  issue  of 
bonds  or  notes,  secured  by  a  prior  or  underlying 
lien. 

Railroad  bonds  are  not  paid  off  at  their  maturity, 


102       RAILROAD  BONDS  AND  NOTES 

as  a  rule,  in  the  sense  that  the  obligation  is  discharged 
and  no  other  takes  its  place.  It  is  the  practise  to 
take  up  an  issue  of  bonds  or  notes  when  due  with 
bonds  or  notes  of  a  new  issue.  The  old  issue  is  re- 
tired by  being  exchanged  for  the  bonds  of  the  new 
issue  or  by  being  paid  off  with  the  proceeds  of  such 
new  issue. 

The  bonds  of  such  new  issue  are  the  refunding 
bonds,  as  they  refund  the  old  issue  and  so  succeed, 
under  their  mortgage,  to  the  lien  that  the  latter  had 
on  the  property  of  the  issuing  company. 

Consolidated  companies  use  refunding  issues  to 
refund  or  meet  the  bonds  issued  by  their  constituent 
companies  before  consolidation,  and  secure  them  by  a 
mortgage  upon  the  entire  system. 

The  custom  seems  to  be  to  make  the  refunding 
issue  for  a  larger  sum  than  the  amount  of  the  bonds 
to  be  met  and  retired.  The  excess  is  then  used,  quite 
generally,  to  meet  present  requirements  of  the  road, 
for  new  construction  contemplated,  or  to  pay  for  ad- 
ditional equipment,  or  to  provide  money  for  future 
needs. 

The  plan  by  which  the  refunding  is  accomplished 
is  set  forth  in  the  mortgage  in  detail.  Different 
methods  may  be  employed.  The  one  most  common 
and  most  generally  adopted  is  that  by  which  the  old 
bonds  are  retired  in  such  a  manner  as  to  gradually 
substitute  the  refunding  bonds  in  their  place  so  that 
finally  the  lien  of  the  mortgage  securing  the  old  bonds 


MORTGAGE  OR  DEED  OF  TRUST         103 

is  discharged  and  the  lien  of  the  mortgage  securing 
the  refunding  bonds  takes  its  place. 

Under  this  plan  of  refunding,  which  is  the  usual 
one,  the  old  bonds  are  presented  by  their  holders,  at 
maturity,  for  payment,  to  the  trustee  of  the  new  re- 
funding mortgage,  and  are  paid  out  of  the  proceeds 
of  that  new  issue.  Or  the  bonds  of  the  issue  to  be 
retired  are  surrendered  to  the  trustee  for  exchange 
for  bonds  of  the  refunding  issue,  when  that  is  the 
agreement. 

These  bonds  of  the  old  issue,  whether  the  trustee 
received  them  by  exchange  for  bonds  of  the  new 
issue  or  paid  for  them  with  the  proceeds  of  such  new 
bonds,  he  holds  uncanceled;  and  the  mortgage  that 
secured  these  old  bonds  continues  in  effect,  and  con- 
tinues to  secure  them  thus  in  the  possession  of  the 
trustee. 

The  trustee  stamps  upon  the  face  of  such  bonds 
thus  refunded  that  they  are  payable  only  to  him  as 
trustee;  and  thereafter  he  holds  these  bonds  in  trust 
uncanceled.  They  are  thus  continued  alive  so  far 
as  the  railroad  company  is  concerned  so  that  they,  in 
the  hands  of  the  trustee,  shall  be  secured  by  their 
original  underlying  mortgage  and  entitled  to  all  its 
benefits.  And  the  trustee  as  the  holder  in  trust  of 
these  refunded  bonds  has  the  same  rights  under  that 
original  underlying  mortgage,  as  any  bondholder  un- 
der it  had. 

The  trustee  holds  these  bonds  he  has  thus  refunded 


104          RAILROAD  BONDS  AND  NOTES 

for  the  protection  of  all  the  bondholders  of  the  new 
issue.  In  this  way  the  old  issue  is  refunded  bond 
for  bond,  and  each  new  bond  that  refunds  the  old 
bond  takes  the  rights  of  the  latter,  in  effect,  under  the 
underlying  mortgage.  By  this  method  of  gradual 
substitution  the  entire  issue  of  old  bonds  is  met, 
refunded,  and  disposed  of.  Then  the  mortgage  that 
secured  them  is  canceled  of  record  and  removed,  and 
the  lien  of  the  mortgage  that  secures  the  new  issue 
succeeds  to  its  place.  There  then  is  no  longer  need 
that  the  old  bonds  be  continued  alive  to  protect  the 
new  ones  (so  that  they  might  claim,  as  was  seen,  the 
protection  of  the  old  mortgage),  so  they  are  de- 
stroyed by  the  trustee. 

Provision  is  also  made  in  the  mortgage  that  the 
old  bonds  held  by  the  trustee  during  the  progress  of 
the  refunding,  shall  not  draw  interest,  but  that  the 
payment  of  the  interest  on  the  new  refunding  bonds 
shall  be  a  payment  of  interest  on  the  old  bonds  so 
held,  until  default  in  the  payment  of  such  interest, 
whereupon  all  the  rights  that  the  original  holders  of 
the  old  refunded  bonds  had,  may  then  be  enforced 
by  the  trustee,  who  holds  them  for  that  purpose. 
These  rights  that  he  thus  gets  and  enforces  are  for 
the  benefit  of  all  the  holders  of  the  bonds  of  the  re- 
funding issue. 

At  the  time  of  the  issue  of  the  refunding  bonds  all 
of  the  old  issue  may  not  have  matured.  Provision 
is  then  made  for  this  by  reserving  sufficient  refund- 


MORTGAGE  OR  DEED  OF  TRUST    105 

ing  bonds  to  meet  these  old  bonds  as  they  fall  due. 
However,  the  holders  of  the  old  bonds  may  consent 
to  surrender  them  before  maturity  and  exchange 
them  for  bonds  of  the  refunding  issue.  Should  any 
object  to  the  retirement  of  his  bonds  before  matur- 
ity, then  the  trustee  puts  aside  bonds  of  the  refund- 
ing issue  to  meet  those  of  the  old  issue  as  they  fall 
due,  either  by  payment  with  their  proceeds  or  by 
exchange  for  the  bonds  themselves.  The  holders 
of  the  old  issue  are  entitled  to  be  paid  in  cash  and 
cannot  be  compelled  to  accept  bonds  of  the  new  issue 
unless  they  agreed  to  this  in  some  way. 

(t)     Provisions  for  converting  the  bonds  into  the 
capital  stock  of  the  railroad  company. 

The  option  or  privilege  is  contained  in  some  rail- 
road bonds  or  mortgages,  by  which  the  holder  may 
convert  his  bond  into  the  capital  stock  of  the  issuing 
company,  or  for  such  other  securities  as  may  be  agreed 
upon. 

This  right  to  convert  is  an  incident  of  the  bond 
and  passes  with  it  from  holder  to  holder  and  may  be 
exercised  by  whomsoever  is  the  holder  at  the  time 
when  the  stock  may  be  demanded.  This  right  may 
not  be  assigned  separately  from  the  bond. 

When  the  bondholder  exercises  this  option  or 
privilege  and  exchanges  his  bond  for  stock  of  the  rail- 
road company,  he  is  no  longer  a  bondholder  and 
creditor  of  the  company,  but  he  becomes  a  stock- 


106  RAILROAD  BONDS  AND  NOTES 

holder  and  therefore  a  member  of  the  debtor  com- 
pany. As  such  he  has  privileges  which  as  a  bond- 
holder he  did  not  possess,  such  as  receiving  dividends, 
voting,  and  having  a  voice  in  the  selection  of  the 
corporate  officers  by  whom  the  affairs  of  the  company 
shall  be  managed.  In  the  distribution  of  the  assets 
of  an  insolvent  road,  as  a  stockholder  he  is  entitled 
to  his  proportionate  share  of  such  assets  after  all  the 
debts  of  the  railroad  company  have  been  paid  in  full. 
The  bondholders  of  the  corporation,  like  other  cred- 
itors, are  entitled  to  be  paid  in  full  before  the  stock- 
holders receive  anything. 

To  become  a  stockholder,  the  stock  must  have  been 
actually  issued  to  him.  That  he  demanded  it  and 
was  legally  entitled  to  receive  it  does  not  make  him  a 
stockholder.  The  stock  must  have  been  actually 
issued  to  him. 

To  exercise  this  option  or  privilege  the  bondholder 
must  surrender  his  bond  in  proper  form  to  the  rail- 
road company  and  make  a  demand  for  the  securities 
strictly  upon  the  terms  set  forth  in  the  option. 

The  time  when  and  the  price,  value,  or  ratio,  at 
which  the  conversion  shall  be  made  are  mentioned 
in  the  mortgage. 

Time  requirements  must  be  strictly  observed. 
And  where  the  conversion  must  be  made  on  or  before 
maturity,  or  on  or  before  any  designated  day,  the 
holder  must  present  his  bond  and  demand  his  stock 
on  or  before  the  time  specified  else  he  loses  his  rights 


MORTGAGE  OR  DEED  OF  TRUST         107 

under  his  option.  The  courts  hold  that  under  the 
circumstances,  the  railroad  company  is  entitled  to 
know  on  or  before  the  maturity  of  the  bonds,  or  on  or 
before  such  other  day  as  may  be  specified  for  the  con- 
version, whether  the  holder  elects  to  take  stock  or 
money,  so  that  the  stock  which  is  not  taken  may  be 
sold  and  the  proceeds  applied  to  the  payment,  in 
money,  of  the  bonds. 

Should  no  time  be  specified  within  which  the 
holder  may  convert  his  bond,  then  the  option  must 
be  exercised  within  a  reasonable  time.  What  con- 
stitutes a  reasonable  time  depends  upon  the  facts  and 
circumstances  of  each  particular  case. 

The  demand  for  the  conversion  must  be  made  at  a 
reasonable  hour  on  or  before  the  day  upon  which  the 
option  expires. 

When  the  option  to  convert  is  lost  it  is  gone  for- 
ever. The  law  holds  that  to  extend  the  time,  or,  if 
already  expired,  to  renew  it,  a  new  agreement  is 
necessary.  An  extension  of  the  time  for  the  pay- 
ment of  the  bonds,  when  the  option  to  convert  ex- 
pired at  maturity,  does  not  of  itself  extend  the  time 
for  conversion  to  the  new  date  of  maturity.  A  new 
special  agreement  is  necessary. 

The  consolidation  of  the  issuing  railroad  company 
with  another,  or  with  others,  cannot  defeat  the  right 
of  the  bondholder  to  convert.  The  terms  of  the 
statute  or  the  agreement  under  which  the  consolida- 
tion is  effected  cannot  be  forced  upon  him  summarily. 


io8  RAILROAD  BONDS  AND  NOTES 

He  is  not  permitted,  however,  to  interfere  with  the 
consolidation.  He  is  entitled  to  a  reasonable  notice 
of  the  intended  consolidation  and  a  fair  opportunity 
to  exercise  his  rights  and  demand  stock  of  the  com- 
pany that  issued  his  bond  before  it  consolidates. 
Should  he  not  demand  his  stock  within  the  reasonable 
time  that  must  be  allowed  him;  or,  should  he  by 
word  or  act  participate  in  the  consolidation  (by  which 
the  issuing  company  loses  its  legal  identity  and  power 
to  issue  stock),  he  will  not  be  heard  later  to  com- 
plain, and  any  rights  he  may  have  had  to  convert  his 
bond  into  the  stock  of  the  issuing  company  up  to  the 
time  of  the  consolidation,  will  cease  with  such  con- 
solidation. 

However,  the  rights  of  the  holders  of  bonds  with 
the  option  of  conversion  are  quite  generally  provided 
for  in  the  arrangement  for  consolidation,  whether  by 
statute  or  agreement.  As  a  general  rule  the  consol- 
idated company  assumes  or  has  imposed  upon  it  all 
the  liabilities  of  its  constituent  companies,  including 
this  one  of  conversion;  and  the  consolidated  com- 
pany will  issue  its  own  stock  to  meet  the  demands  of 
the  holders  of  this  option  against  the  roads  thus  con- 
solidated or  merged. 

Should  the  railroad  company  upon  proper  demand 
refuse  to  deliver  the  stock,  the  holder  of  the  convert- 
ible bond  had  his  election  of  two  remedies.  He  may 
sue  the  issuing  company  for  money  damages  for 
breach  of  this  agreement;  or  he  may  compel  the  de- 


MORTGAGE  OR  DEED  OF  TRUST         109 

livery  of  the  stock,  when  that  is  possible.  In  the  first 
action,  the  measure  of  damages  is  the  market  value 
of  the  stock  at  the  time  it  was  refused,  less  the  value 
of  the  bond.  If  the  bonds  are  to  be  taken  up  at  their 
maturity  with  stock,  then  the  measure  of  damages  is 
the  market  value  of  the  stock  at  that  time,  less  the 
value  of  the  bond  at  that  time.  The  suing  bond- 
holder in  each  instance  retains  his  bond,  hence  the 
deduction  of  its  value  in  each  case.  Should  he  turn 
over  his  bond,  or  be  ordered  to  do  so  by  the  court,  its 
value  then  is  considered  in  arriving  at  the  amount  of 
his  damages. 

In  the  action  to  compel  the  delivery  of  the  stock  it 
is  no  answer  for  the  railroad  company  to  say  that  it 
had  none  of  its  stock  ready  and  that  it  cannot  acquire 
any  except  at  ruinous  prices  upon  the  market.  It 
should  have  provided  against  such  a  contingency. 
And  where  it  is  an  impossibility  to  procure  the  stock, 
even  at  a  loss  to  the  issuing  company,  it  must  answer 
in  money  damages  and  pay  the  value  of  the  stock  at 
the  time  it  should  have  been  delivered. 

The  relative  price,  value,  or  ratio  at  which  the 
bonds  shall  be  exchanged  for  stock  is  fixed  in  the 
mortgage.  This  is  the  conversion  parity.  When 
the  convertible  bond  and  the  stock  for  which  it  may 
be  exchanged  are  quoted  at  the  price,  value,  or  ratio 
fixed  in  the  mortgage,  the  conversion  parity  is  said  to 
be  maintained.  The  holder  of  the  convertible  bond 
seeking  gain  by  the  conversion,  of  course,  watches  for 


110  RAILROAD  BONDS  AND  NOTES 

the  time  when  the  conversion  is  in  his  favor,  and  if 
it  be  during  the  period  within  which  he  may  convert, 
he  then  exercises  his  option. 

(u)     Re-possession  by  the  railroad  after  receiver- 
ship or  possession  by  the  trustee. 

The  default  of  the  railroad  company  in  the  pay- 
ment of  interest  or  principal  of  the  bonds  may  have 
been  caused  by  conditions  that  were  temporary  only ; 
and  after  the  receiver  or  the  trustee  has  taken  pos- 
session, it  may  be  able  to  retrieve  its  lost  standing. 
It  may  then  be  in  a  position  to  pay  all  that  is  due 
under  the  mortgage.  It  is  but  just  that  it  should  be 
given  this  opportunity  to  do  so,  and  it  is  usually  to 
the  advantage  of  the  bondholders  that  it  should  pay 
up  and  retake  possession  of  the  road  and  resume 
operation,  as  it  thereby  prevents  the  sacrifice  that 
usually  attends  a  forced  sale  of  property  and  the 
resultant  loss  to  the  bondholders  and  other  creditors. 

Railroad  mortgages  accordingly  contain,  without 
exception,  a  provision  that  at  such  a  time  the  railroad 
company  by  paying  all  that  is  due  under  the  mortgage 
and  the  expenses  that  have  been  incurred,  shall  be 
entitled  to  the  re-possession  of  the  road  as  if  no  de- 
fault had  taken  place. 

It  is  usually  provided  that  the  railroad  company 
shall  exercise  this  right  at  any  time  up  to  the  actual 
sale  of  the  property  at  foreclosure. 

And  should  the  railroad  company  be  restored  to 


MORTGAGE  OR  DEED  OF  TRUST         111 

possession  under  these  circumstances  and  resume  the 
operation  of  the  road,  it  shall  not  affect  the  rights  of 
the  trustee  or  the  bondholders  to  again  take  posses- 
sion of  the  mortgaged  property  or  to  foreclose  the 
mortgage  and  ask  for  a  receiver  upon  a  subsequent 
default. 

(v)     Remedies  to  enforce  the  mortgage. 

Immediately  upon  the  failure  of  the  railroad  com- 
pany to  pay  an  instalment  of  interest,  or  the  princi- 
pal, or  an  instalment  of  principal,  or  to  perform  any 
of  the  obligations  of  the  mortgage,  the  rights  and 
remedies  of  the  trustee  in  behalf  of  the  bondholders 
to  realize  on  the  security  may  be  enforced,  in  the 
absence  of  any  provision  to  the  contrary.  To  guard 
against  the  harm  that  will  result  in  disrupting  a  road 
by  a  foreclosure,  or  the  taking  of  possession  by  the 
trustee,  when  the  company  may  be  only  temporarily 
embarrassed,  the  usual  railroad  mortgage  provides 
that  the  rights  and  remedies  to  realize  on  the  security 
shall  be  enforced  only  when  the  non-payment  of 
interest  shall  have  continued  for  a  specified  period, 
usually  three  or  six  months. 

The  principal  of  the  bonds  must  be  paid  when 
due  and  no  provision  for  a  period  of  grace  is  con- 
tained in  the  mortgage  as  in  the  case  of  interest;  the 
same  rule  quite  generally  applies  to  the  payment  of 
an  instalment  of  principal.  However,  the  remedies 
to  enforce  the  security  with  relation  to  failure  to  pay 


112  RAILROAD  BONDS  AND  NOTES 

principal,  or  an  instalment  of  principal,  when  due,  or 
with  relation  to  other  defaults  under  the  mortgage, 
may  be  postponed  by  the  mortgage ;  the  time  of  grace 
in  each  instance  is  mentioned. 

The  trustee  has  no  power  to  waive  any  default  by 
the  railroad  company  without  the  consent  of  the 
bondholders,  unless  the  mortgage  gives  him  that 
power. 

It  is  sometimes  provided  in  the  mortgage  that  the 
trustee  must,  upon  the  application  of  the  holders  of 
a  certain  proportion  of  the  outstanding  bonds,  fore- 
close the  mortgage,  or  pursue  any  of  the  other  rem- 
edies that  the  mortgage  may  give  him,  as  they  shall 
elect;  and  that  he  may  act  with  respect  to  these  rem- 
edies only  when  empowered  by  the  holders  of  the 
requisite  proportion  of  bonds.  Should  there  be  no 
limitation  upon  the  action  of  the  trustee,  then  he 
may  use  his  own  judgment. 

The  remedy  that  the  law  gives  upon  default  by 
the  railroad  company,  independent  of  any  that  the 
mortgage  may  contain,  is  the  right  to  foreclose  the 
mortgage  and  ask  for  the  appointment  of  a  receiver 
to  take  possession  of  the  road  and  operate  it  during 
the  foreclosure  proceedings.  The  receiver  then  holds 
the  road  until  a  sale  is  had  or  a  reorganization  of  the 
company  is  perfected. 

The  railroad  consents,  so  far  as  it  can,  to  the  ap- 
pointment of  a  receiver  upon  the  application  of  the 
trustee;  and  it  agrees  in  its  mortgage  that  with  rela- 


MORTGAGE  OR  DEED  OF  TRUST         113 

tion  to  legal  proceedings  instituted  by  others  than  the 
trustee,  it  will  not  suffer  or  voluntarily  permit  a 
receiver  to  be  appointed  of  its  property  unless  with 
the  consent  of  the  trustee. 

In  addition  to  the  right  of  foreclosure  which  the 
law  gives  independently  of  any  provision  in  the  mort- 
gage, the  usual  form  of  railroad  mortgage  confers 
on  the  trustee  the  power  to  sell  the  mortgaged  prop- 
erty with  or  without  entering  into  possession. 
Should  he  take  possession  of  the  road  under  such 
power  granted  him  by  the  mortgage,  he  is  usually 
permitted  by  the  mortgage  to  operate  the  road  until 
all  the  claims  under  his  mortgage  are  satisfied  and 
paid  or  adequately  provided  for. 

In  granting  this  power  to  sell,  or  to  operate  and 
to  sell,  the  mortgage  usually  makes  its  exercise  de- 
pendent upon  the  will  of  the  holders  of  a  certain  pro- 
portion of  the  bonds  then  outstanding;  and  that  the 
trustee  shall  only  exercise  such  powers  when  the 
holders  of  the  designated  proportion  of  the  outstand- 
ing bonds  shall  request  it.  The  minority  are  bound 
by  the  act  of  the  specified  majority,  when  the  mort- 
gage contains  such  provision. 

The  sale  by  the  trustee  under  this  power,  is  at 
public  auction  after  due  advertising  and  notice. 
The  time  and  place  of  such  sale  and  the  kind  and 
amount  of  advertising  and  notice  is  specified  in  the 
mortgage. 

As  this  power  to  the  trustee  to  operate  and  to  sell 


114          RAILROAD  BONDS  AND  NOTES 

is  the  result  of  an  agreement  of  the  parties,  that 
same  agreement,  the  mortgage,  specifies  how  he  shall 
distribute  the  proceeds  of  his  operation  of  the  road 
and  its  sale.  It  is  usually  to  the  effect  that  he  shall 
first  pay  the  charges  and  expenses  of  the  sale  and  of 
the  trusteeship;  and  then  if  the  property  be  sold  sub- 
ject to  prior  liens,  that  he  apply  the  balance  to  the 
payment  of  the  bonds  and  interest  under  the  mort- 
gage. Should  the  property  be  sold  free  and  clear  of 
all  prior  liens,  then  before  he  pays  the  bondholders 
under  his  mortgage  he  must  first  pay  those  liens 
entitled  to  priority  over  his  mortgage.  Besides 
those  liens  entitled  to  priority  over  his  mortgage,  he 
must  pay  in  full  all  unpaid  taxes,  assessments  and 
governmental  charges  before  he  pays  his  bondhold- 
ers anything.  The  holders  of  the  outstanding  bonds 
under  the  mortgage  are  usually  paid  without  prefer- 
ence to  whether  the  principal  of  their  bonds  is  due 
or  yet  to  become  due.  Claims  for  principal  and  in- 
terest usually  stand  on  an  equal  footing;  neither  has 
preference  over  the  other,  though  the  mortgage  may 
provide  for  priorities  among  the  bonds  and  the 
coupons.  See  Priorities,  if  any,  between  principal 
and  interest.  Page  92.  Also  see  Priorities  among 
interest  coupons  and  claims  for  interest.  Page  260. 
Should  the  fund  realized  by  the  trustee  be  insuf- 
ficient to  pay  all  the  bonds  and  the  interest  coupons 
in  full,  when  they  all  stand  on  an  equal  footing,  they 
share  proportionately.  Should  the  mortgage  provide 


MORTGAGE  OR  DEED  OF  TRUST         115 

for  any  preference  or  priority  among  the  bonds  and 
the  coupons,  they  are  paid  according  to  the  order  of 
preference  thus  arranged.  Among  classes  of  cred- 
itors entitled  to  liens  or  other  priorities,  each  class  is 
paid  in  full  before  those  of  the  class  next  in  rank 
receive  anything. 


CHAPTER  IV 

RIGHTS    AND    REMEDIES    WITH    RELATION    TO 
THE    TRUSTEESHIP 

Relation   between   bondholders,   noteholders   and 
trustee  generally. 

The  rights  and  remedies  of  the  bondholders  under 
their  mortgage,  broadly  speaking,  are  held  and  en- 
forced for  their  benefit  by  the  trustee.  The  trustee 
represents  the  bondholders.  The  mortgage,  or  deed 
of  trust,  as  it  is  sometimes  called,  is  made  to  the 
trustee,  he  is  the  party  to  it  and  not  the  bondholders ; 
it  is  to  him  that  the  property  is  conveyed  as  security; 
the  remedies  to  realize  on  the  security  are  enforced 
primarily  by  him;  he  sees  that  the  railroad  company 
performs  all  it  is  obliged  to  under  the  mortgage, 
among  other  things,  that  the  property  pledged  by 
the  mortgage  is  properly  cared  for  and  conserved  by 
it,  that  it  is  properly  applying  its  income  to  the  pay- 
ment of  interest  or  principal  of  the  bonds  when  due, 
and  that  these  moneys  are  not  diverted  to  other  pur- 
poses; and  it  is  the  duty  of  the  trustee  to  bring  law- 
suits or  to  defend  them  to  enforce  or  guard  the  inter- 
ests of  his  bondholders. 

While  the  railroad  company  is  paying  interest  on 

116 


RELATION  TO  THE  TRUSTEESHIP       117 

the  bonds  as  it  accrues  and  doing  all  that  it  should 
do  under  the  mortgage,  the  duties  of  the  trustee  are 
merely  passive.  When  there  is  a  default  by  the  rail- 
road company,  his  duties  become  at  once  active  and 
decisive.  He  must  take  then  such  immediate  steps 
as  will  best  protect  and  serve  the  interests  of  his 
bondholders.  The  remedies  that  the  trustee  usually 
pursues  are  discussed  in  the  next  chapter.  See 
Chapter  V .  Rights  and  Remedies  with  relation  to 
Foreclosing  the  Mortgage  or  Otherwise  Realizing  on 
the  Security.  Page  146. 

Reasons  for  trusteeship. 

Railroad  mortgages  are  made  usually  to  secure  an 
issue  of  bonds  for  large  sums,  offered  for  sale  in  the 
money  markets  of  nearly  every  civilized  country  of 
the  world,  and  held  in  time  by  persons  scattered  by 
residence  or  travel  over  the  universe.  It  must  be 
apparent  how  impracticable  it  would  be  to  have  each 
bondholder  a  party  to  the  mortgage  that  secured  his 
bonds.  Then  every  transfer  of  a  bond  would  re- 
quire the  transfer  of  a  corresponding  interest  in  the 
mortgage.  This  would  destroy  that  capacity  of 
railroad  bonds  for  quick  and  ready  transfer,  and  de- 
prive them  of  that  negotiability  that  the  law,  when- 
ever it  can,  endeavors  to  give  them. 

By  reason  of  frequent  transfers,  the  holders  of  an 
issue  constantly  change.  And  if  every  bondholder 
were  a  party  to  the  mortgage,  originally  or  by  reason 


ii8  RAILROAD  BONDS  AND  NOTES 

of  assignment,  then  all  would  be  necessary  parties  to 
any  suit  upon  the  mortgage;  and  to  have  this  large 
and  everchanging  number  unite  in  a  lawsuit  would 
seriously  interfere  with,  if  not  entirely  prevent,  the 
enforcing  of  the  security.  It  is  necessary,  therefore, 
that  one  or  several  representatives  shall  be  chosen  to 
act  for  all. 

Who  are  chosen  as  trustees. 

Individuals  are  sometimes  chosen  as  trustees  of 
railroad  mortgages.  The  tendency,  however,  is  to 
name  a  trust  company.  The  combination  of  an  in- 
dividual, or  a  committee  of  individuals,  with  a  trust 
company  is  sometimes  employed.  It  seems  that  trust 
companies  are  chosen  because  they  are  better 
equipped  than  individuals  to  act  as  trustees  of  rail- 
road mortgages.  Many  trust  companies  make  a 
specialty  of  trusteeship  of  this  kind,  and  maintain 
departments  conducted  by  men  experienced  and 
skilled  in  the  peculiar  nature  of  the  work.  Further- 
more, their  financial  resources,  as  a  rule,  are  greater 
than  those  of  individuals. 

Courts  hold  trustees  strictly  to  their  duties. 

Because  of  the  delicacy  of  the  relation  that  exists 
between  a  trustee  and  his  bondholders,  the  courts 
zealously  guard  the  interests  of  the  latter  and  hold 
the  trustees  to  strict  accountability.  The  law  de- 
mands that  his  conduct  be  characterized  always  by 


RELATION  TO  THE  TRUSTEESHIP       119 

loyalty  to  the  interests  that  are  entrusted  to  him. 
He  must  act  with  care  and  prudence  and  always  in 
good  faith. 

Liability  of  trustee  to  his  bondholders;  limitation 
of  liability;  acts  of  representatives;  losing 
rights  against  trustee;  liability  of  trustee  to 
third  persons;  indemnity  to  trustee. 

The  trustee  must  answer  to  his  bondholders  for 
any  loss  they  may  suffer  through  his  misconduct  in 
office  or  failure  to  faithfully  discharge  his  duties. 
Railroad  mortgages  usually  limit  the  liability  of  their 
trustees  in  some  particulars.  Bondholders  by  ac- 
cepting their  bonds  consent  to  such  limitations  of 
liability  contained  in  the  mortgage.  The  usual  lim- 
itation is  that  the  trustee  shall  be  liable  to  the  bond- 
holders only  for  his  own  wilful  default  or  miscon- 
duct. The  trustee  is  held  responsible  usually  only 
for  reasonable  diligence  in  the  management  of  the 
trusteeship.  He  is  not  held  answerable  to  his  bond- 
holders for  the  wrongful  act,  or  default,  or  failure 
to  act,  of  any  agent  or  representative,  unless  he  did 
not  use  reasonable  care  in  the  selection  of  such  repre- 
sentative. If  he  used  reasonable  care  in  selecting 
his  employees  or  representatives,  he  is  not  liable  to 
his  bondholders  for  any  loss  sustained  by  their  wrong- 
ful act  or  failure  to  act. 

Bondholders  may  lose  their  rights  to  recover  dam- 
ages or  for  other  relief  against  the  trustee,  should  they 


120  RAILROAD  BONDS  AND  NOTES 

have  consented  by  word  or  conduct  to  the  act  com- 
plained of,  or  in  any  way  participated  in  it.  Such 
consent  may  have  been  given  prior  to  the  act  com- 
plained of,  or  it  may  consist  of  a  subsequent  ratifica- 
tion or  acceptance  of  the  unauthorized  act  of  the 
trustee.  Those  bondholders  who  have  thus  counte- 
nanced improper  official  acts  will  not  be  heard  to 
complain  against  that  which,  in  law,  they  have  con- 
sented to. 

As  to  third  persons,  the  trustee  is  liable  personally 
to  them,  while  operating  the  road,  for  any  injury  to 
their  persons  or  their  property,  committed  by  his  rep- 
resentatives or  by  himself.  But  it  is  invariably  ar- 
ranged in  railroad  mortgages  that  the  trustee  shall  not 
personally  pay  such  losses,  but  that  they  shall  be 
borne  by  the  trust  property,  and  the  trust  property 
is  accordingly  charged  with  a  first  lien  in  favor  of 
the  trustee  for  his  security  and  indemnification 
against  such  liability.  A  third  person  continues,  not- 
withstanding such  an  arrangement,  entitled  to  receive 
his  damages  from  the  trustee ;  the  provision  is  for  the 
reimbursement  of  the  trustee  and  does  not  affect  the 
rights  of  such  third  persons  who  are  not  parties  to  it. 

Many  railroad  mortgages  provide  that  the  trustee 
shall  not  be  obliged  to  take  any  action  to  carry  out 
the  trusteeship,  which  in  his  opinion  shall  be  likely 
to  involve  him  in  expense  or  liability,  unless  he  shall 
be  first  indemnified  against  such  expense  or  liability 
by  the  bondholders  in  whose  behalf  he  shall  act. 


RELATION  TO  THE  TRUSTEESHIP       121 

Bondholders  are  bound  by  the  official  acts  of  the 
trustee. 

In  representing  his  bondholders,  the  trustee  binds 
them  by  whatever  he  does  officially  in  their  behalf. 
The  bondholders  are  thus  bound  by  the  acts  of  the 
trustee  only  when  he  acts  strictly  within  the  scope 
of  his  authority  as  their  trustee.  The  bondholders 
will  not  be  bound  by  the  acts  of  the  trustee  when  he 
is  acting  only  for  the  railroad  company,  or  in  any 
matter  outside  of  the  mortgage,  as  in  reorganization 
or  other  collateral  transactions,  unless  he  is  specifi- 
cally authorized  by  them. 

Remedies  of  bondholders  against  their  trustee; 
money  damages;  injunction;  removal;  com- 
pelling performance  of  acts. 

Bondholders  are  entitled  to  sue  the  trustee  per- 
sonally and  recover  such  damages  in  money,  as  shall 
compensate  them  for  any  loss  they  may  have  suffered 
as  a  result  of  his  improper  official  acts.  See  Liabil- 
ity of  trustee  to  his  bondholders;  limitation  of  liabil- 
ity, etc.  Page  119. 

They  are  also  entitled  to  an  injunction  to  restrain 
any  act  of  the  trustee  that  will  waste  or  impair  the 
property  that  may  come  into  his  possession  under 
the  mortgage.  And  when  his  acts  imperil  the  safety 
of  the  property  under  his  control,  and  his  continuing 
in  office  is  a  menace  to  the  interests  of  the  bondhold- 
ers, in  addition  to  the  injunction  restraining  him 


122  RAILROAD  BONDS  AND  NOTES 

from  acting  further,  they  are  entitled  to  ask  the  court 
to  remove  him. 

The  court  may  compel  the  trustee  to  actually  per- 
form certain  acts  within  his  duties;  accordingly, 
among  other  things,  bondholders  may  compel  their 
trustee  to  take  possession  of  the  road  and  operate  it, 
when  it  is  his  duty  under  the  mortgage  to  do  so. 

Co-trustees;  majority;  liability  of  co-trustees  for 
acts  of  each  other;  succession  by  continuing 
trustee. 

Where  there  are  two  or  more  trustees  all  must  con- 
cur to  give  validity  to  an  official  act,  unless  the  mort- 
gage otherwise  provides.  Each  trustee  has  an  equal 
right  in  the  execution  of  the  trust  and  an  equal  power 
over  the  trust  property.  The  decision  of  a  majority 
has  no  force  as  a  general  proposition  of  law.  Rail- 
road mortgages,  however,  usually  cover  this  contin- 
gency and  quite  generally  provide  that  the  vote  of 
a  majority  of  its  trustees  shall  decide  all  questions 
before  them.  However,  when  a  proper  expenditure 
is  made  the  consent  of  co-trustees  is  not  necessary. 

One  trustee  is  not  personally  responsible  to  the 
bondholders  for  the  misconduct  of  his  co-trustee. 
Where,  however,  a  trustee  stands  by  and,  without 
protest,  permits  his  co-trustee  to  commit  a  fraud  with 
relation  to  the  trusteeship,  and  he  does  not  take  steps 
to  protect  his  bondholders,  the  law  declares  that  this 
shall  be  deemed  an  acquiescence  in  the  wrong  act, 


RELATION  TO  THE  TRUSTEESHIP       123 

though  there  be  no  actual  participation,  and  renders 
him  personally  liable  to  them. 

When  there  are  two  or  more  trustees  and  a  part  of 
that  number  is  removed,  or  otherwise  incapacitated 
from  acting,  the  rights  and  powers  that  all  had  pass 
to  the  trustee  or  trustees  remaining.  The  title  to 
the  property  under  the  mortgage  passes  to  the  con- 
tinuing trustee  or  trustees. 

Trustee  may  not  delegate  to  others  the  powers 
requiring  his  individual  skill;  details  only  may 
be  delegated. 

The  trustee  may  not  delegate  to  others  the  exercise 
of  those  powers  which  the  bondholders  are  justified 
in  assuming  will  be  carried  out  by  him.  He  may 
not  relieve  himself  from  performing  those  services 
that  call  for  executive  control  and  management  of 
the  trusteeship.  With  regard  to  such  services  per- 
sonal attention  is  the  basis  of  his  duty. 

One  would  not  consent  to  have  another  act  for  him 
unless  he  had  a  certain  confidence  in  the  standing, 
talents,  and  general  fitness  of  such  person.  His  ca- 
pacity for  administration,  his  knowledge  of  the  af- 
fairs of  the  railroad  company  are  important  factors 
that  influence  the  appointment  of  a  trustee.  Bond- 
holders are  entitled  to  assume,  therefore,  that  he  will 
employ  these  qualities,  talents  and  special  knowl- 
edge for  their  benefit  and  will  not  delegate  the  per- 
formance of  duties  requiring  this  skill  to  others. 


124  RAILROAD  BONDS  AND  NOTES 

Matters  of  detail  that  do  not  call  for  skill  of  the 
nature  discussed,  may  be  performed  by  subordinates 
or  representatives. 

Personal  interest  of  the  trustee  in  the  property  for- 
bidden when  antagonistic  to  bondholders ;  pur- 
chase of  trust  property  by  trustee ;  remedies  of 
bondholders;  acceptance  or  rejection;  waiving 
or  losing  remedies  against  trustee. 

The  law  will  permit  no  self-seeking  by  the  trus- 
tee. There  must  be  no  fraud  or  collusion  on  his  part. 
Every  act  of  the  trustee  that  will  prejudice  the  inter- 
ests of  the  bondholders  will  be  condemned  by  the 
courts. 

The  trustee  must  not  act  for  his  personal  advantage 
in  dealing  with  the  property  that  is  the  subject  mat- 
ter of  his  trusteeship. 

There  must  be  no  clashing  of  his  duty  as  trustee 
and  his  individual  interests.  Such  a  situation  sub- 
jects the  security  to  risk.  Accordingly,  the  law 
forbids  the  trustee  purchasing  any  part  of  the  trust 
property  for  himself,  without  rendering  himself 
liable  to  account  to  the  bondholders  therefor.  But 
he  may  purchase  on  behalf  of  his  bondholders  at  the 
foreclosure  sale  when  authorized  by  them  to  do  so. 
He  then  holds  the  property  so  purchased  subject  to 
the  direction  of  the  bondholders. 

The  law  recognizes  human  infirmity  and  sees  the 


RELATION  TO  THE  TRUSTEESHIP       125 

inevitable  conflict  between  duty  and  self-interest. 
The  vice,  however,  of  the  personal  interest  of  the 
trustee  merely  taints  his  purchase  of  the  trust  prop- 
erty ;  it  does  not  make  such  purchase  absolutely  void. 
That  is,  it  is  optional  with  the  bondholders  whether 
or  not  they  will  accept  or  reject  a  purchase  or  other 
dealing  with  the  trust  property  by  their  trustee. 
Should  it  be  beneficial  to  the  bondholders,  they  may 
accept  and  enforce  it;  should  it  not  be  to  their  satis- 
faction they  may  ask  the  court  to  declare  it  void. 

Until  the  bondholders  by  some  act  show  their 
intention  to  avoid  such  purchase,  or  other  personal 
dealing,  by  the  trustee,  it  will  continue  in  force.  It 
is  good  until  it  is  set  aside.  And  the  law  will  assume 
that  the  bondholders  have  accepted  and  confirmed  the 
purchase,  or  other  personal  dealing,  if  they  fail  to 
object  within  a  reasonable  time.  Their  acquiescence 
will  be  inferred  from  their  failure  to  object  within  a 
reasonable  time. 

Should  the  bondholders  reject  the  transaction,  then 
the  trustee  should  be  put,  so  far  as  can  be  done,  in 
the  position  he  occupied  before  his  purchase  or  other 
personal  dealing  with  the  property.  The  bondhold- 
ers may  not  cling  to  the  proceeds  of  the  transaction 
they  seek  to  avoid;  and  the  trustee  should  have  re- 
turned to  him,  so  far  as  under  the  circumstances  it 
can  be  done,  what  he  parted  with  when  making  the 
purchase  complained  of. 


126  RAILROAD  BONDS  AND  NOTES 

Litigation  is  conducted  by  the  trustee ;  bondholders 
are  then  bound  by  decisions  of  the  courts ;  ap- 
pearance by  bondholders;  indemnity  and  de- 
mand by  certain  proportion  of  bondholders; 
when  trustee  loses  right  to  litigate. 

Litigation  affecting  the  mortgaged  property  is  car- 
ried on  by  the  trustee  in  behalf  of  the  bondholders. 
He  represents  them  in  all  legal  proceedings  affecting 
the  trusteeship. 

Should  a  trustee  act  under  several  mortgages  and 
should  there  be  a  contest  for  priority  or  preference 
between  the  different  classes  of  bondholders  under 
these  several  mortgages,  the  court  will  direct  that 
each  class  be  represented  by  a  separate  trustee  who 
will  be  solely  concerned  in  enforcing  that  one  mort- 
gage and  getting  for  those  whom  he  represents  all 
they  are  entitled  to. 

Bondholders  are  bound  by  the  decisions  of  the 
courts  in  legal  proceedings  in  which  they  are  repre- 
sented by  their  trustee,  with  the  same  effect  as  if 
each  bondholder  were  a  party  to  the  suit.  And  in  all 
litigation  affecting  the  trusteeship  or  the  trust  prop- 
erty, whatever  legal  steps  the  trustee  is  bound  by, 
generally  speaking,  the  bondholders  are  bound  by. 
When  the  trustee  acts  fraudulently  or  outside  the 
scope  of  his  authority  the  bondholders  are  not  bound 
by  his  acts. 

Notwithstanding  that  the  bondholders  are  repre- 
sented by  their  trustee  in  all  litigation,  they  are 


RELATION  TO  THE  TRUSTEESHIP       127 

entitled  to  appear  before  the  court  in  all  proceedings 
there  pending,  to  ask  it  to  protect  their  interests  when 
necessary. 

Railroad  mortgages  often  provide  that  the  trustee 
shall  have  the  exclusive  right  to  conduct  all  litiga- 
tion under  it,  and  that  the  bondholders  shall  not  bring 
any  legal  proceedings  under  the  mortgage,  unless  the 
trustee  shall  have  failed  to  do  so,  after  having  been 
requested  in  writing  by  the  holders  of  a  certain  pro- 
portion in  amount  of  the  bonds  then  outstanding. 
Some  mortgages  further  provide  that  in  addition  to 
such  request,  there  shall  be  tendered  to  the  trustee  a 
reasonable  indemnity  against  his  expenses  and  liabil- 
ity, before  he  shall  be  required  to  bring  legal  action. 
With  such  a  provision  in  the  mortgage,  the  trustee 
need  not  proceed  with  litigation  until  requested  by 
the  proper  proportion  of  bondholders  and,  if  indem- 
nity be  required,  until  such  indemnity  be  tendered. 

The  trustee  may  lose  his  right  to  conduct  the  lit- 
igation of  trusteeship.  Then  the  courts  permit  bond- 
holders to  litigate  in  all  matters  necessary  to  protect 
their  rights  under  the  mortgage,  instead  of  the  trustee. 

The  trustee  loses  his  right  to  litigate  under  the 
mortgage  when  he  acts  fraudulently  or  in  collusion 
with  others;  or  occupies  such  a  position  that  his 
personal  interests  conflict  with  those  of  his  bondhold- 
ers; or  his  attitude  is  hostile  to  their  welfare.  Bond- 
holders may  also  sue  instead  of  the  trustee  when  he 
improperly  refuses  or  neglects  to  proceed. 


128  RAILROAD  BONDS  AND  NOTES 

If  the  mortgage  provides  that  the  trustee  need  not 
proceed  with  litigation  until  a  demand  to  do  so  has 
been  served  on  him  by  the  holders  of  a  specified 
amount  or  proportion  of  the  outstanding  bonds,  or 
that  he  be  first  indemnified  against  any  possible  per- 
sonal loss,  then  it  must  be  shown  that  a  proper  de- 
mand or  offer  of  indemnity  has  been  made  in  accord- 
ance with  the  terms  of  the  mortgage  in  that  regard 
and  the  trustee  notwithstanding  has  failed  to  pro- 
ceed. 

Bondholders  may  conduct  litigation  instead  of 
trustee ;  one  or  more  sues  for  all ;  all  bound  by 
decision  of  the  courts. 

When  the  trustee  has  lost  his  right  to  represent  the 
bondholders  before  the  court,  by  his  fraud,  neglect, 
or  hostile  attitude,  one  or  more  bondholders,  instead 
of  the  trustee,  may  conduct  the  litigation  of  the  trus- 
teeship. 

Those  bondholders  who  thus  conduct  the  litiga- 
tion, do  so  on  behalf  of  all  bondholders  secured  by 
the  same  mortgage.  This  is  on  the  rule  of  law  that 
when  a  large  body  of  persons  have  common  rights 
and  it  is  impracticable  that  all  join  and  prosecute  a 
lawsuit,  one  or  more  may  litigate  in  behalf  of  all. 
Holders  of  a  large  issue  of  railroad  bonds,  many  of 
whom  reside  or  sojourn  in  different  parts  of  the 
world,  constitute  such  a  body,  and  the  law  recognizes 
how  impracticable  it  is  to  bring  all  together  to  unite 


RELATION  TO  THE  TRUSTEESHIP       129 

in  a  lawsuit;  and,  accordingly,  the  law  will  not 
allow  this  circumstance  to  unreasonably  delay,  if  not 
defeat,  their  rights  and  remedies. 

The  same  situation  that  makes  it  imperative  that 
the  bondholders  act  through  a  trustee  necessitates  that 
a  very  large  body  of  bondholders  be  represented  by 
one  or  a  comparatively  small  number.  Their  inter- 
ests are  common.  What  affects  one  affects  all.  The 
action  is  brought  by  the  few  for  the  benefit  of  all. 
The  decision  of  the  court  has  in  view  and  protects 
the  rights  of  all,  whether  absent  or  present.  And 
all  are  affected  by  .the  decision  of  the  court,  and 
bound  by  it,  whether  appearing  personally  in  the  lit- 
igation or  not. 

The  court  will  not  permit  those  bondholders  who 
are  active  in  the  litigation  to  gain  any  advantage  over 
the  others.  The  rights  of  all  are  before  the  court 
and  it  protects  the  interests  of  all. 

When  one  or  more  bondholders  litigate  instead  of 
the  trustee,  then  whatever  rights  and  remedies  the 
latter  had  to  sue  under  the  mortgage,  pass  to  the  lit- 
igating bondholder  or  bondholders,  and  are  exercised 
by  them  for  all. 

Bondholders  suing  on  individual  holdings ;  recourse 
to  security;  provisions  barring  suits  on  indi- 
vidual holdings. 

Each  bondholder  may  sue  the  railroad  company  on 
his  bond  in  his  own  behalf  without  restraint  of  any 


130  RAILROAD  BONDS  AND  NOTES 

kind,  unless  the  mortgage  contains  a  provision  that 
bars  his  individual  suit  or  regulates  it  in  some  way. 

A  bondholder,  however,  by  his  suit  on  his  individ- 
ual holding  gains  no  advantage  over  the  holders  of 
the  other  bonds  secured  by  the  same  mortgage,  so 
far  as  the  security  under  the  mortgage  is  concerned; 
because,  after  obtaining  his  judgment,  he  is  permitted 
only  to  satisfy  it  out  of  the  property  covered  by  the 
mortgage  after  the  claims  of  the  other  bondholders 
have  been  satisfied  in  full,  as  the  lien  of  his  judg- 
ment, against  that  property,  comes  after  the  lien  of 
the  mortgage.  He  may  satisfy  his  judgment,  how- 
ever, from  other  property  belonging  to  the  railroad 
company  not  covered  by  any  lien,  and  also  out  of 
property  against  which  prior  liens  exist  after  all  such 
liens  have  been  satisfied  in  full. 

The  right  of  a  bondholder  to  bring  individual  suit 
on  his  bond  is  usually  barred  by  a  provision  in  the 
mortgage.  This  provision  is  usually  to  the  effect 
that  the  rights  and  remedies  of  the  bondholders  under 
the  mortgage  shall  be  enforced  only  through  the 
trustee.  This  is  a  waiver  by  the  bondholder  of  his 
right  to  bring  his  individual  suit  in  his  own  be- 
half. 

Should  the  trustee  by  his  wrongful  act  lose  his 
right  to  represent  the  bondholders  in  litigation 
affecting  the  mortgage,  it  does  not  mean  that  the 
bondholder  when  barred  by  the  mortgage  may  then 
sue  on  his  individual  holding. 


RELATION  TO  THE  TRUSTEESHIP       131 

Provisions  in  the  mortgage  barring  bondholders 
from  suing  on  their  individual  holdings  do  not  affect 
the  right,  conferred  by  law,  on  one  or  more  bond- 
holders on  behalf  of  all  to  institute  or  defend  litiga- 
tion affecting  the  mortgage  when  the  trustee  by  im- 
proper conduct  has  lost  the  right  to  do  so. 

Selection   of   the   trustee;    general   scope   of   his 
powers. 

The  selection  of  the  trustee  in  the  first  instance  is 
made  by  the  railroad  company.  From  this  it  should 
not  be  inferred  that  he  is  subject  to  its  control  or  more 
friendly  disposed  towards  it  than  towards  the  bond- 
holders. See  Courts  hold  trustees  strictly  to  their 
duties.  Page  118. 

When  the  trustee  accepts  his  office  he  assumes  cer- 
tain clearly  defined  duties  to  all  parties  interested  in 
the  mortgage  and  the  mortgaged  property.  He  can 
act  with  relation  to  the  trusteeship  and  the  mort- 
gaged property  only  with  such  powers  as  the  mort- 
gage expressly  or  inferentially  confers,  or  with  which 
the  bondholders  may  clothe  him  by  collateral  con- 
sent, or  with  which  the  law  grants  him  independently 
of  the  mortgage. 

The  trustee  has  no  power  to  waive  a  default  by  the 
railroad  company  in  the  payment  of  any  money  un- 
der the  mortgage ;  nor  has  he  power  to  relieve  it  from 
doing  anything  it  is  obliged  to  do  under  the  mort- 
gage; nor  has  he  power  to  alter  or  modify  any  of 


132  RAILROAD  BONDS  AND  NOTES 

the  terms  of  the  mortgage.  He  has  no  powers  to 
recognize  subsequent  and  inferior  liens  and  give  them 
rank  equal  or  superior  to  that  of  his  mortgage.  The 
trustee  may  only  do  those  things  just  mentioned 
when  the  mortgage  gives  him  that  power  or  the  bond- 
holders specifically  consent  thereto. 

Duties  of  the  trustee  generally;  duties  before  de- 
fault; duties  after  default;  the  remedies  he 
pursues. 

Railroad  mortgages  contain  many  provisions  reg- 
ulating the  trusteeship  and  prescribing  the  duties  of 
the  trustee.  His  duties  are  governed  largely  by  the 
terms  of  the  mortgage,  and  any  subsequent  agree- 
ment to  which  he  is  a  party.  In  addition  to  those 
duties  thus  imposed  on  him,  by  agreement,  he  is 
subject  also  to  those  duties  that  the  law  imposes  on 
trustees  who  have  undertaken  a  trusteeship  involv- 
ing the  peculiar  relations  that  exist  between  holders 
of  railroad  bonds  and  the  trustee  of  railroad  mort- 
gages and  which  affect  railroad  property. 

While  the  railroad  company  is  paying  interest  and 
doing  all  it  should  under  the  mortgage,  the  duties  of 
the  trustee  are  merely  nominal.  They  are  limited  to 
certifying  the  bonds  of  the  issue,  seeing  that  the 
interest  is  paid  and  keeping  the  property  covered  by 
the  mortgage  under  observation  so  that  it  will  not  be 
wasted.  When  there  is  a  default  by  the  railroad 
company,  his  duties  become  active  and  he  should  take 


RELATION  TO  THE  TRUSTEESHIP       133 

immediate  steps  to  protect  the  rights  of  his  bond- 
holders. 

The  trustee,  generally,  has  at  his  command  three 
remedies  to  pursue  in  behalf  of  his  bondholders. 
One  of  these  he  adopts. 

(1)  He  may  take  possession  of  the  mortgaged 
property   (which  is  usually  the  entire  road  or  an 
entire  branch  or  line)  when  the  mortgage  gives  him 
that  power,  and  operate  it  until  the  money  due  under 
his  mortgage  is  either  paid  or  adequately  provided 
for;  and,  if  necessary,  he  may  sell  the  property  he 
thus  acquires,  and  satisfy  the  claims  under  the  mort- 
gage out  of  the  proceeds.     This  is  a  remedy  that  he 
does  not  possess  as  a  matter  of  law,  he  may  only 
pursue  this  course  when  the  mortgage  gives  him  that 
power. 

(2)  Another  remedy  that  the  trustee  does  not 
possess  unless  the  mortgage  expressly  gives  it  is  the 
power  to  sell  the  mortgaged  property  at  public  auc- 
tion, without  entering  into  possession  or  operating  it. 
This  and  the  preceding  remedy  (where  he  does  enter 
into  possession  and  operate)    are  usually  granted 
trustees  by  railroad  mortgages. 

(3)  The  third  remedy  and  the  one  which  the 
trustee  usually  adopts  in  preference  to  the  others  is 
that  which  the  law  gives  him  independently  of  the 
mortgage,  that  is,  the  right  to  foreclose  the  mortgage. 
Trustees  invariably  resort  to  this  remedy  as  the  oper- 
ation of  the  railroad  or  its  sale  by  a  trustee  imposes 


134  RAILROAD  BONDS  AND  NOTES 

upon  him  new  responsibilities  which,  as  a  rule,  they 
seek  to  avoid.  Trustees,  therefore,  usually  place  the 
entire  matter  before  the  court  for  its  action  by  fore- 
closing the  mortgage.  The  court  then,  in  a  proper 
case,  appoints  a  receiver,  who,  under  its  direction, 
takes  possession  and  control  of  the  mortgaged  road 
and  property  and  operates  it  until  it  is  sold  at  the 
foreclosure  sale  or  until  the  railroad  company  is  re- 
organized and  such  property  is  taken  over. 

Discretion  of  the  trustee  in  carrying  out  details  of 
the  trusteeship. 

The  trusteeship  of  a  railroad  mortgage  involves 
many  details.  It  would  be  impracticable  for  the 
trustee  to  seek  the  advice  or  permission  of  the  court 
or  the  bondholders  with  relation  to  each  detail.  To 
cloak  the  trustee  with  a  reasonable  discretion  in  per- 
forming acts  of  this  character  is  a  necessity  of  the 
situation.  And  the  bondholders  by  accepting  him  as 
their  trustee,  thereby  expressing  their  faith  and  con- 
fidence in  him,  justify  the  law  in  permitting  him  to 
act  according  to  his  best  judgment  in  carrying  out 
such  details.  However,  this  discretion  is  not  an  arbi- 
trary one.  And  no  matter  how  wide  a  discretion 
may  be  given  a  trustee,  it  is  subject  always  to  review 
by  the  courts  on  the  inquiry  as  to  whether  or  not  he 
has  abused,  violated,  or  over-reached,  his  discretion. 
It  is  difficult  to  state  even  the  nature  of  those  acts 
which  the  trustee  may  perform  according  to  his  dis- 


RELATION  TO  THE  TRUSTEESHIP       135 

cretion,  and  those  to  perform  which  he  must  first 
obtain  permission  of  the  court,  the  bondholders,  or 
other  interested  parties.  The  decision  of  this  ques- 
tion depends  entirely  upon  the  facts  and  surrounding 
circumstances  of  each  case  presented;  and  each  case 
has  its  own  particular  facts. 

Trustee  seeking  advice  of  court ;  advising  with 
legal  counsel;  guided  by  opinion  of  bondhold- 
ers ;  rights  of  majority ;  rights  of  minority. 

In  the  course  of  the  trusteeship  under  a  railroad 
mortgage,  situations  may  arise  that  are  not  provided 
for  in  the  mortgage;  or  the  trustee  may  be  met  with 
conditions  upon  which  his  duty  is  doubtful ;  or  ques- 
tions of  unusual  difficulty  may  present  themselves. 
The  trustee  should  then  apply,  as  a  general  rule,  to 
the  court  for  its  aid  and  direction. 

Railroad  mortgages  may  provide,  and  they  usually 
do,  that  the  trustee  may  advise  with  legal  counsel, 
and  the  opinion  of  the  latter  shall  be  a  full  protec- 
tion and  justification  to  the  trustee  for  his  acts  in 
good  faith  and  in  accordance  with  such  opinion  and 
advice. 

The  trustee  may  also  seek  the  advice  of  the  bond- 
holders. The  trustee  is  not  justified  in  following  the 
advice  or  will  of  the  majority,  no  matter  how  large, 
unless  the  mortgage  states  that  the  voice  of  such 
majority  shall  prevail.  The  trustee  must  act  for  the 
bondholders  as  a  class,  and  not  for  a  majority  of  that 


136  RAILROAD  BONDS  AND  NOTES 

class.  In  some  of  the  railroad  mortgages  it  is  pro- 
vided that  the  will  of  the  holders  of  a  majority,  or 
a  majority  of  a  specified  proportion  or  amount,  of 
the  outstanding  bonds  under  the  mortgage,  shall  con- 
trol with  regard  to  those  certain  matters  which  are 
there  clearly  specified. 

In  such  case  the  minority  will  not  be  heard  to 
oppose  what  they  have  consented  to.  Each  bond- 
holder when  he  accepted  his  bond  agreed  to  its  terms 
and  all  the  provisions  and  conditions  of  the  mort- 
gage accompanying  it,  and,  in  this  particular,  gave 
to  the  majority  the  power  to  speak  for  him.  Should 
the  mortgage  not  contain  sucjh  provision,  the  ma- 
jority do  not  have  this  power;  it  must  be  expressly 
granted  by  the  mortgage  in  plain  terms. 

However,  when  the  mortgage  does  not  confer  this 
power  on  the  majority,  it  is  not  improper  that  the 
trustee  be  guided  by  the  opinion  of  the  majority, 
when  what  they  advise  is  not  inconsistent  with  the 
provisions  of  the  mortgage  and  is  urged  in  good 
faith.  But  the  will  of  the  majority  cannot  be  forced 
under  these  circumstances  upon  the  minority  and, 
upon  their  objection,  the  court  will  examine  into  the 
proposed  action  of  the  trustee.  If  the  proposed  plan 
of  the  trustee  be  fraudulent  or  if  it  violates  any  of 
the  rights  of  the  minority,  the  court  will  prevent  it 
by  injunction;  but,  where  the  proposed  action  of  the 
trustee  under  the  advice  of  the  majority  is  fair  and 
does  not  violate  any  of  the  provisions  of  the  mort- 


RELATION  TO  THE  TRUSTEESHIP       137 

gage,  the  court  will  permit  the  trustee  to  carry  out 
such  suggestions  of  the  majority. 

The  action  of  the  court  in  the  situation  just  dis- 
cussed is  founded  upon  the  peculiar  relation  that 
exists  between  the  holders  of  bonds  issued  by  a  rail- 
road corporation,  a  quasi-public  corporation. 

Removal  of  trustee ;  by  bondholders ;  by  court ;  for 
cause. 

The  trustee  may  be  removed  by  the  court  for  mis- 
conduct in  office. 

Should  the  trustee  prove  unsatisfactory  or  unde- 
sirable, railroad  mortgages  usually  provide  for  his 
removal  by  the  bondholders,  though  no  reason  may 
exist  such  as  the  court  requires  before  it  will  remove 
a  trustee.  Such  a  provision  is  usually  to  the  effect 
that  the  trustee  shall  be  considered  removed  from 
office  when  the  holders  of  a  certain  proportion  of  the 
outstanding  bonds  (usually  more  than  a  bare  ma- 
jority) shall  file  a  writing,  showing  the  amount  of 
their  respective  holdings  and  their  desire  to  remove 
the  trustee.  Thereupon  he  is  removed  from  office 
and  may  not  act  further. 

Where  the  mortgage  makes  no  such  provision  for 
the  removal  of  the  trustee  by  the  bondholders,  or  the 
requisite  holdings  do  not  unite  under  such  a  pro- 
vision he  may  be  removed  by  the  court,  but  for  cause 
only. 

The  cause  for  removing  a  trustee,  generally  speak- 


138  RAILROAD  BONDS  AND  NOTES 

ing,  is  a  breach  by  him  of  some  duty  of  his  trustee- 
ship. Such  breach  may  be  the  doing  of  an  act  which 
he  should  not  do,  or  failing  to  do  something  he 
should  do. 

The  wrongful  act  or  omission  to  act  must  be  such 
as  endangers  the  rights  of  the  bondholders  he  repre- 
sents or  jeopardizes  the  security.  Should  his  con- 
tinuing in  office  be  detrimental  to  the  interests  of  the 
bondholders  he  may  be  removed. 

The  good  faith  of  the  trustee  is  often  a  matter  that 
the  courts  consider  upon  an  application  for  his  re- 
moval. A  mere  error  in  judgment  is  not  cause  for 
his  removal,  unless  it  shows  want  of  capacity  or  in- 
dicates dishonesty.  In  this  relation  railroad  mort- 
gages usually  provide  that  the  trustee  may  advise 
with  legal  counsel,  whose  opinion  shall  be  a  full  pro- 
tection and  justification  for  the  trustee  for  any  act 
done  in  good  faith  and  in  accordance  with  such 
opinion. 

The  trustee  may  be  removed  for  having  a  per- 
sonal interest  in  the  property,  the  subject  matter  of 
the  trusteeship,  antagonistic  to  that  of  his  bondhold- 
ers. The  rigid  rule  that  the  trusteeship  must  be 
managed  solely  for  the  benefit  of  those  in  whose  be- 
half it  is  undertaken  is  never  relaxed. 

Neglecting  to  give  his  personal  attention  to  his 
duties  is  ground  for  removing  a  trustee.  However, 
this  relates  only  to  the  general  executive  control  of 
the  affairs  of  the  trusteeship  that  calls  for  the  skill 


RELATION  TO  THE  TRUSTEESHIP       139 

and  capacity  of  the  trustee,  and  not  to  matters  of  de- 
tail which  may  be  performed  by  a  subordinate  or 
other  representative.  Foreign  residence  by  a  trus- 
tee, permanently  and  often  temporarily,  where  it 
renders  the  full  discharge  of  his  duties  doubtful,  may 
be  cause  for  his  removal. 

Any  fraud  or  connivance  on  the  part  of  the  trus- 
tee subjects  him  to  removal.  He  must  act  always 
in  the  highest  faith  and  pursuant  to  his  honest  and 
disinterested  judgment. 

Resignation  by  trustee. 

When  the  trustee  accepts  his  office  he  assumes  all 
its  obligations  and  may  not  avoid  its  responsibilities 
by  resigning  or  refusing  to  act  unless  with  the  con- 
sent of  the  railroad  company  and  of  the  bondholders, 
or  by  order  of  the  court. 

Provisions  for  resignation  by  trustee;  filling  va- 
cancies in  the  trusteeship. 

Railroad  mortgages,  however,  usually  provide  for 
the  resignation  by  the  trustee  and  for  filling  the  va- 
cancy thus  created.  When  the  mortgage  does  not 
provide  for  the  resignation  by  the  trustee  and  the 
appointment  of  a  new  one  in  his  place,  it  may  be 
done  only  on  the  consent  of  the  bondholders  and  the 
other  parties  interested,  or  by  order  of  the  court. 
The  court  has  the  power  to  appoint  a  new  trustee. 

When  the  trustee  is  permitted  by  the  mortgage 


140  RAILROAD  BONDS  AND  NOTES 

to  resign,  it  is  usually  provided  that  he  shall  give 
notice  of  his  intention  to  the  bondholders  and  to  the 
railroad  company,  by  advertisements  in  the  news- 
papers, and  shall,  if  requested,  execute  and  deliver 
to  his  successor  any  legal  documents  necessary  to  pass 
the  trusteeship  on.  Ordinarily,  such  documents  are 
not  necessary,  as  it  is  usually  provided  in  the  mort- 
gage that  the  new  trustee  upon  taking  office  shall  be 
possessed  of  all  the  rights  of  the  former  trustee,  and 
that  the  latter  shall  become  divested  immediately  of 
such  rights  upon  his  being  separated  from  office. 

The  court  will  not  allow  a  trusteeship  to  fail  or  to 
be  neglected  for  want  of  a  trustee  or  the  misconduct 
of  a  trustee.  This  power  of  the  court  does  not  de- 
pend upon  any  provision  of  the  mortgage;  it  is  a 
power  that  is  inherent  in  a  court  of  equity. 

Should  the  mortgage  arrange  for  the  appointment 
of  a  new  trustee,  the  court  will  make  the  appoint- 
ment thus  agreed  upon.  The  agreement  of  the  par- 
ties in  this  regard  will  govern  the  appointment  and 
not  the  general  law. 

The  modes  adopted  by  these  agreements  to  fill 
vacancies  in  the  trusteeship,  whether  contained  in  the 
mortgage  or  subsequently  made,  take  various  forms. 
Those  most  common,  and  of  which  one  is  followed, 
are  that  the  new  trustee  shall  be  selected  by  the  hold- 
ers of  a  majority,  or  other  proportion,  in  amount  of 
the  bonds  then  outstanding;  or  that  the  railroad  com- 
pany shall  appoint  the  new  trustee;  or  that  a  certain 


RELATION  TO  THE  TRUSTEESHIP       141 

court  shall  make  the  appointment;  or  where  there 
are  several  trustees  that  those  remaining,  either 
unanimously  or  by  a  majority  vote,  as  the  case  may 
be,  shall  name  their  new  associate. 

It  is  also  provided  sometimes  that  in  the  interval 
between  when  the  vacancy  occurs  and  the  new  trus- 
tee assumes  office,  the  duties  of  the  trusteeship  shall 
be  performed  by  one  selected  by  the  board  of  direc- 
tors of  the  railroad  company. 

The  qualifications  that  the  new  trustee  shall  pos- 
sess are  often  specified.  The  usual  requirements  are 
that  the  new  trustee  shall  be  a  trust  company  of  good 
standing  with  a  specified  capital  surplus  and  undi- 
vided profits  and  doing  business  in  a  certain  city  or 
state;  or  that  he  be  a  bondholder. 

Compensation  of  the  trustee ;  fixed  by  mortgage  or 
agreement  or  by  the  court. 

A  reasonable  compensation  is  paid  to  the  trustee 
for  his  services  in  the  execution  of  his  trusteeship. 
His  compensation  may  be  fixed  in  the  mortgage  or 
by  another  agreement  between  all  the  parties  in  in- 
terest. When  there  is  litigation  and  the  affairs  of 
the  trusteeship  are  before  the  court,  it  then  fixes  the 
amount  of  the  trustee's  compensation. 

The  court  in  allowing  compensation  to  trustees, 
as  a  rule,  will  take  into  consideration  the  actual  work 
necessarily  done.  There  is  no  fixed  basis  of  com- 
pensation that  the  courts  employ.  The  amount  fixed 


142  RAILROAD  BONDS  AND  NOTES 

will  be  proportioned  to  the  work  that  was  necessary 
and  actually  rendered. 

Bondholders  are  entitled  to  appear  before  the 
court  and  contest  the  amount  which  it  allows  the 
trustee  if  they  believe  it  to  be  unreasonably  large. 

Expenses  of  the  trusteeship;  compensation  and 
expenses  paid  by  railroad  company  or  out  of 
the  trust  property;  contribution  by  bondhold- 
ers; expenditures  for  large  or  for  limited 
amounts,  or  for  certain  purposes;  lien  of 
trustee  for  compensation  and  expenditures. 

The  trustee  is  reimbursed  out  of  the  trust  prop- 
erty for  his  compensation  and  the  necessary  expenses 
of  the  trusteeship. 

It  is  not  necessary  that  the  mortgage  make  any 
provision  for  the  expenses  of  the  trusteeship.  It  is 
a  well  settled  rule  of  law  that  trust  property  shall 
bear  the  expenses  of  its  care  and  administration. 

The  payment  of  the  expenses  of  the  trustee  are 
usually  provided  for  in  the  mortgage.  The  railroad 
company  in  its  mortgage  usually  undertakes  to  pay 
the  trustee  for  his  services  and  reimburse  him  for  all 
liability  and  expenses  he  may  incur  by  reason  of  his 
trusteeship.  Such  an  undertaking  on  the  part  of  the 
railroad  company  is  usually  followed  with  the  pro- 
vision that  should  the  railroad  company  not  pay  such 
monies,  then  the  same  shall  be  a  lien  on  the  property 
mentioned  in  the  mortgage,  and  shall  be  paid  out 


RELATION  TO  THE  TRUSTEESHIP       143 

of  the  proceeds  of  the  mortgaged  property  before  any 
payment  therefrom  to  the  bondholders.  This  latter 
provision  for  a  lien,  which  the  mortgage  usually  gives 
the  trustee,  is  unnecessary  because  when  the  expendi- 
tures of  the  trustee  have  been  proper,  his  claim  for 
repayment  and  for  compensation  is_  a  lien  on  the 
property  in  his  charge,  as  a  matter  of  law ;  and  he  is 
paid  in  full  out  of  that  property  for  his  services,  and 
for  his  expenditures,  and  for  any  liability  he  may 
have  incurred  in  the  course  of  his  trusteeship,  before 
the  bondholders  receive  anything. 

It  is  elementary  in  the  law  that  if  a  large  body  of 
persons  have  an  interest  in  a  common  fund  or  the 
same  property,  and  one  of  that  number  takes  proper 
and  necessary  proceedings  to  preserve  that  fund  or 
property  for  their  common  good,  he  is  reimbursed 
out  of  that  property  or  fund  for  his  services  and  all 
monies  so  expended  by  him;  and  if  the  fund  or  prop- 
erty prove  insufficient  then  he  shall  be  reimbursed 
by  those  who  accept  the  benefits  of  his  efforts  and 
expenditures.  The  trustee  of  a  railroad  mortgage, 
under  this  principle,  is  entitled  to  be  paid  for  his 
services  and  reimbursed  for  his  expenditures  out  of 
the  trust  property;  and  if  the  trust  property  be  in- 
sufficient, then  by  proportionate  contribution  from 
the  bondholders  in  whose  behalf  or  at  whose  request 
he  acted. 

The  expenditures  that  a  trustee  is  permitted  to 
make  are  those  necessary  to  preserve  or  repair  the 


144          RAILROAD  BONDS  AND  NOTES 

property  in  his  charge,  including  the  reasonable  fees 
for  legal  counsel  to  necessarily  prosecute  or  defend 
litigation  to  protect  the  property. 

If  the  expenses  of  a  trustee  are  proper  the  ap- 
proval of  a  co-trustee  is  not  necessary. 

Some  railroad  mortgages  provide  that  before  the 
trustee  shall  make  expenditures  beyond  a  certain 
amount  or  for  a  specified  nature,  he  shall  first  obtain 
permission  of  the  bondholders  of  a  certain  proportion 
in  amount  of  the  bonds  then  outstanding.  Expendi- 
tures beyond  the  specified  amount  or  of  the  desig- 
nated character  will  not  be  allowed  the  trustees, 
when  made  without  the  required  permission;  but  if 
the  bondholders  in  the  requisite  amount  subsequently 
approve  these  expenditures  it  will  have  the  same 
force  as  if  they  had  been  authorized  in  the  first  in- 
stance. 

The  trustee  will  not  be  compelled  to  part  with  the 
property  upon  which  he  has  his  lien  for  services  and 
expenditures  until  he  has  been  reimbursed.  This 
lien  of  the  trustee,  however,  must  not  govern  the  sit- 
uation so  as  to  control  the  property  and  interfere 
with  the  working  out  of  the  trusteeship.  The  law 
will  not  allow  the  lien  of  the  trustee  to  defeat  the 
purposes  of  the  trusteeship. 

It  was  seen  that  the  remedies  that  the  trustee  has 
at  his  command  to  realize  on  the  security,  upon  de- 
fault by  the  railroad  company,  are  either  to  enter 


RELATION  TO  THE  TRUSTEESHIP       145 

into  possession  of  the  mortgaged  road  and  to  operate 
it,  and,  if  necessary,  to  sell  it;  or  to  sell  it  without 
entering  into  possession ;  or  to  foreclose  the  mortgage 
and  ask  for  the  appointment  of  a  receiver  to  operate 
the  road  until  it  is  sold  at  foreclosure  or  the  company 
is  reorganized  and  the  property  thus  taken  over. 
These  remedies  are  discussed  in  detail  in  the  follow- 
ing chapter. 


CHAPTER  V 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  FORE- 
CLOSING THE  MORTGAGE  OR  OTHERWISE  RE- 
ALIZING ON  THE  SECURITY 

Three  usual  remedies  to  realize  on  the  security. 

When  the  railroad  company  defaults  under  the 
mortgage,  there  are  usually  three  remedies,  one  of 
which  the  trustee  may  pursue  in  behalf  of  the  bond- 
holders to  realize  on  the  security.  He  may  take 
possession  of  the  mortgaged  property  and  operate  the 
road  and  finally  sell  it,  if  necessary,  when  the  mort- 
gage gives  him  this  authority;  or  he  may  sell  the 
mortgaged  road  and  property  without  taking  posses- 
sion, when  that  power  is  given  him  by  the  mortgage ; 
or  he  may  foreclose  the  mortgage  and  bring  the  en- 
tire matter  into  court.  The  right  to  foreclose  the 
mortgage  is  one  which  the  law  gives  and  is  inde- 
pendent of  any  provision  in  the  mortgage;  it  is  an 
absolute  right  and  does  not  depend  upon  any  grant 
of  power  to  do  so  by  the  mortgage. 

If  there  be  no  provision  to  the  contrary,  the  trus- 
tee may  choose  and  pursue  that  remedy  which  he  be- 
lieves will  best  serve  the  interests  of  the  bondholders. 

146 


FORECLOSING  THE  MORTGAGE          147 

In  many  mortgages,  however,  it  is  left  to  the  will 
of  the  holders  of  a  certain  proportion  in  amount  of 
the  outstanding  bonds  to  decide  which  course  the 
trustee  shall  pursue.  These  provisions  are  generally 
to  the  effect  that  the  trustee  shall  only  take  posses- 
sion of  the  mortgaged  road  and  operate  it,  or  sell  it, 
when  requested  to  do  so  by  the  holders  of  a  specified 
proportion  in  amount  of  the  outstanding  bonds.  In 
some  mortgages  there  is  a  provision  that  the  trustee 
need  not  proceed  to  take  possession  of  the  mortgaged 
road  and  operate  it,  even  though  requested  by  the 
requisite  proportion  of  the  bondholders,  until  they 
furnish  him  with  indemnity  against  any  loss  he  may 
suffer  or  liability  he  may  incur  while  so  operating 
the  mortgaged  road  under  the  mortgage. 

When  the  mortgage  confers  on  the  trustee  the 
power  to  sell  the  mortgaged  road,  with  or  without 
taking  possession  and  operating  it,  it  does  not  pre- 
clude or  limit  the  right  to  apply  to  the  court  for  the 
foreclosure  of  the  mortgage.  The  policy  of  the  law 
is  to  aid  the  bondholders  in  obtaining  payment  of 
their  bonds  and  interest  and  enforcing  their  security, 
and  anything  in  a  railroad  mortgage  that  restricts 
the  right  to  foreclose  will  be  strictly  construed;  and 
whenever  possible,  the  court  will  decide  against  any 
provision  which  tends  to  limit  the  right  of  the  trus- 
tee or  the  bondholders  to  foreclose  their  mortgage. 


148  RAILROAD  BONDS  AND  NOTES 

When  the  right  to  commence  proceedings  accrues ; 
what  constitutes  a  default;  in  interest;  in 
principal. 

The  right  to  enforce  the  security,  which  the  mort- 
gage or  the  law  gives,  accrues  upon  a  default  by  the 
railroad  company. 

A  default  may  be  a  failure  to  pay  interest  or  prin- 
cipal, or  an  instalment  of  principal,  in  the  manner 
required  in  the  bond  or  the  mortgage ;  or  a  failure  on 
the  part  of  the  railroad  company  to  perform  any  of 
the  duties  it  has  undertaken  in  the  bond  or  the  mort- 
gage; or  the  doing  of  an  act  which  it  should  not  do 
and  which  subjects  the  mortgaged  property  to  risk 
and  jeopardizes  the  security. 

The  right  to  proceed  to  enforce  the  remedies  is 
complete  as  a  matter  of  law,  immediately  upon  de- 
fault by  the  railroad  company;  but  railroad  mort- 
gages usually  contain  provisions  with  regard  to  de- 
faults, either  postponing  the  time  when  legal  pro- 
ceedings may  be  commenced  thereon  or  making  the 
action  of  the  trustee  to  foreclosure,  or  otherwise  pro- 
ceed against  the  mortgaged  property,  dependent  upon 
the  wishes  of  the  trustee  or  of  holders  of  a  specified 
proportion  in  amount  of  the  outstanding  bonds. 

Reasons  for  provisions  postponing  action  by 
trustee  or  holders. 

The  failure  to  pay  interest,  or  principal,  or  an  in- 
stalment of  principal,  on  the  day  on  which  it  is  pay- 


FORECLOSING  THE  MORTGAGE          149 

able  is  such  a  default,  in  the  absence  of  anything  in 
the  mortgage  to  the  contrary,  as  will  entitle  the  trus- 
tee to  commence  immediately  any  of  the  proceedings 
he  may  have  at  his  command,  under  the  conditions 
previously  discussed.  But  it  is  recognized  that  un- 
due haste  in  this  regard  may  cause  an  unnecessary 
sacrifice  of  property  and  bring  about  a  disorganiza- 
tion of  the  railroad  company  to  the  injury  of  the 
bondholders  and  the  others  interested  in  its  affairs. 
Railroad  mortgages,  therefore,  quite  generally  pro- 
vide that  all  proceedings  by  the  trustee  to  realize  on 
the  mortgaged  property  shall  be  subject  to  certain 
conditions,  or  shall  be  postponed  until  the  expira- 
tion of  a  certain  period. 

It  may  well  happen  that  a  road  in  its  first  years 
may  not  earn  enough  to  pay  its  running  expenses,  its 
necessary  repairs,  and  the  interest  on  its  bonds.  A 
temporary  financial  depression,  an  unexpected  falling 
off  of  revenue  or  of  income,  unusual  expenditures, 
or  extraneous  circumstances  may  interfere  with 
prompt  payments  even  by  an  established  road.  Rec- 
ognizing these  possible  conditions  and  in  order  to 
enable  a  railroad  company,  in  good  faith,  to  tide  over 
a  period  of  temporary  embarrassment,  railroad  mort- 
gages usually  contain  provisions  regulating  defaults 
in  the  payment  of  interest. 

A  provision  of  this  character  most  common  is  that 
no  action  shall  be  taken  by  the  trustee,  or  by  the 
bondholders,  to  enforce  the  security  for  a  default  in 


150  RAILROAD  BONDS  AND  NOTES 

interest  until  the  interest  shall  continue  unpaid  for 
a  specified  period  after  it  is  due  and  payable,  usually 
three  or  six  months.  On  short  term  obligations  this 
period  of  grace  is  usually  sixty  days;  and  on  ob- 
ligations running  for  a  year  or  so  no  provision 
of  this  kind  is  made.  Another  such  provision  is 
that  the  trustee  shall  proceed  to  enforce  the  mort- 
gage only  upon  the  request  of  the  holders  of  a 
certain  proportion  in  amount  of  the  outstanding 
bonds. 

Principal  may  fall  due  upon  default  in  interest; 
when  it  does  not ;  option  of  bondholders  to  de- 
clare principal  due. 

Upon  default  in  payment  of  an  instalment  of  in- 
terest the  whole  principal  sum  of  the  bond  may  fall 
due  and  be  payable. 

It  is  sometimes  stated  in  railroad  mortgages  that 
when  a  default  shall  be  suffered  in  the  payment  of 
an  instalment  of  interest,  and  such  default  shall  have 
continued  for  the  specified  period,  usually  three  or 
six  months,  then  the  principal  of  all  bonds  secured 
by  the  mortgage  and  then  outstanding  shall  become 
due  and  payable  immediately. 

When  the  interest  has  remained  unpaid  for  the 
specified  period  and  is  in  default  the  mortgage  may 
provide  that  the  trustee  may  declare  due  the  princi- 
pal of  the  bonds,  if  he  deem  it  advisable;  or  the 


FORECLOSING  THE  MORTGAGE          151 

mortgage  may  say  that  he  must  declare  it  due,  leav- 
ing him  no  discretion  in  the  matter;  or  the  mortgage 
may  direct  that  the  trustee  shall  declare  the  princi- 
pal due  only  upon  receiving  from  the  holders  of  a 
certain  proportion  in  amount  of  the  outstanding 
bonds  a  demand  to  that  effect. 

The  usual  provision  is  that  the  principal  shall  be- 
come due  upon  a  default  in  interest,  only  when  the 
holders  of  a  specified  proportion  in  amount  of  the 
then  outstanding  bonds  shall  declare  it  due.  That 
is,  it  shall  be  optional  with  the  bondholders  whether 
or  not  the  principal  shall  become  due  and  payable 
upon  such  default  in  interest.  Should  the  holders 
of  the  specified  proportion,  in  amount  usually  a 
majority,  of  the  bonds  then  outstanding  desire  that 
the  principal  shall  so  become  due,  they  request  the 
trustee  to  notify  the  railroad  company  that  the 
principal  of  the  bonds  is  declared  due.  Having 
consented  to  this  provision  in  the  mortgage  by  ac- 
cepting their  bonds  under  such  mortgage,  the  mi- 
nority are  bound  by  the  act  of  the  majority  in  this 
regard. 

If  there  be  nothing  said  in  the  bond  or  the  mort- 
gage as  to  the  principal  falling  due  upon  a  failure  to 
pay  interest,  nor  should  it  be  declared  due,  then  the 
foreclosure,  or  other  proceeding,  as  a  rule,  is  limited 
to  realize  for  the  satisfaction  of  the  defaulted  inter- 
est only. 


152  RAILROAD  BONDS  AND  NOTES 

Default  may  be  waived;  rights  of  trustee  and  of 
majority  bondholders  to  waive  default. 

A  default  by  the  railroad  company  in  the  payment 
of  interest  may  be  waived.  Bondholders  at  certain 
times,  and  under  some  conditions,  may  deem  it  wise 
to  defer  legal  action  and,  accordingly,  may  waive  a 
default  in  the  payment  of  an  instalment  of  interest. 

Railroad  mortgages  usually  provide  for  waiving 
defaults.  A  fairly  common  provision  is  to  the  effect 
that  the  holders  of  a  specified  proportion,  in  amount, 
of  the  outstanding  bonds  secured  by  the  mortgage, 
may  waive  the  default  by  the  company  at  any  time 
before  the  property  is  sold. 

When  no  legal  proceedings  have  been  begun,  a 
waiver  merely  means  that  matters  continue  as  there- 
tofore; however,  when  legal  proceedings  have  been 
instituted,  then  upon  such  waiver  the  railroad  com- 
pany is  restored  to  all  former  rights  and  to  posses- 
sion of  the  mortgaged  property,  and  all  the  rights, 
remedies,  and  powers  of  the  trustee  and  the  bond- 
holders continue,  as  theretofore,  as  if  no  procedings 
to  enforce  the  mortgage  had  been  taken. 

A  waiver  of  one  default,  it  is  usually  provided, 
shall  not  be  understood  as  a  waiver  of  any  other  or 
later  default;  nor  shall  it  affect,  in  any  way,  the 
rights  and  remedies  of  the  trustee  or  the  bondholders 
with  respect  to  enforcing  the  mortgage  for  any  other 
or  later  default. 

The  trustee  has  no  power  to  waive  a  default  by 


FORECLOSING  THE  MORTGAGE          153 

the  railroad  company  unless  the  mortgage  gives  him 
that  authority,  or  the  bondholders  by  separate  con- 
sent clothe  him  with  this  power;  nor  have  a  ma- 
jority of  the  bondholders  any  power  to  waive  a  de- 
fault unless  the  mortgage  confers  that  right  on 
them. 

Redemption    by    railroad    company    and    its    re- 
possession. 

Upon  default  by  the  railroad  company,  should  the 
trustee  take  possession  of  the  road  under  authority 
contained  in  the  mortgage,  he  is  entitled  to  hold  it 
until  the  amount  then  due  is  either  paid  or  ade- 
quately provided  for. 

However,  the  usual  form  of  railroad  mortgage 
provides  that  while  the  trustee  is  in  possession  of  the 
road,  or  foreclosure  proceedings  are  in  progress,  the 
railroad  company  shall  have  the  right  at  any  time 
before  the  sale  to  have  the  mortgaged  road  restored 
to  it  upon  payment  of  the  amount  due  for  principal 
and  interest  and  of  all  costs,  fees,  expenses,  and  al- 
lowances. Should  all  not  be  then  due,  the  court  per- 
mits the  railroad  company  to  have  repossession  upon 
paying  what  is  then  due  and  adequately  providing 
for  the  monies  not  yet  due. 

Restoring  the  road  to  the  company  in  this  way 
does  not  affect  the  right  of  the  trustee  to  again  take 
possession  of  the  road  or  foreclose  the  mortgage  for 
any  subsequent  default. 


154  RAILROAD  BONDS  AND  NOTES 

Possession  and  operation  of  the  road  by  the  trustee ; 
lease  of  the  road;  operation  optional  with 
trustee  or  with  bondholders;  rights  and  liabil- 
ities of  trustee  while  operating ;  income  during 
this  period;  distribution  of  moneys  received 
by  trustee ;  his  duties  while  operating  road ;  ex- 
penses, contracts,  repairs,  supplies,  and  help, 
incidental  to  operation;  contracts  of  the  rail- 
road company  as  affecting  trustee;  liability  of 
trustee  for  negligence  of  employees. 

As  was  seen,  the  trustee  is  entitled  to  hold  posses- 
sion of  the  road  he  has  taken  under  the  terms  of  the 
mortgage  until  the  money  due  is  either  paid  or  ade- 
quately provided  for.  The  railroad  company  will 
not  be  entitled  to  repossession  until  this  has  been 
done.  So  long  as  there  appears  to  be  any  need  that 
the  trustee  shall  have  possession  he  is  entitled  to  re- 
tain it.  Some  railroad  mortgages  authorize  the 
trustee  to  lease  the  road  to  others  willing  to  operate 
it  instead  of  doing  so  himself,  should  he  deem  such 
a  course  advisable.  The  period  and  the  other  de- 
tails of  the  lease  are  sometimes  regulated  in  the  mort- 
gage; though  they  may  be  left  to  the  discretion  of 
the  trustee. 

Whether  or  not  the  trustee  will  take  possession  of 
the  road  under  the  terms  of  the  mortgage  and  operate 
it,  rests  in  his  discretion,  unless  there  is  some  pro- 
vision in  the  mortgage  to  the  contrary. 

Railroad    mortgages    sometimes    reserve    to    the 


FORECLOSING  THE  MORTGAGE          155 

bondholders  the  right  to  decide  whether  or  not  the 
trustee  shall  take  possession  of  and  operate  the  road; 
and,  accordingly,  the  mortgage  may  provide  that  he 
may  do  so  only  when  requested  by  the  holders  of  a 
certain  percentage,  in  amount,  of  the  bonds  then  out- 
standing. When  the  requisite  number  make  the  de- 
mand the  trustee  must  take  possession  of  the  road 
and  operate  it.  Under  such  a  provision  in  the  mort- 
gage, the  trustee  may  not  proceed  of  his  own  will ;  he 
may  only  act  when  requested  in  the  manner  speci- 
fied in  the  mortgage. 

It  is  not  unusual  for  the  railroad  mortgage  to  pro- 
vide, however,  that  the  trustee  may  in  his  own  dis- 
cretion, and  must  upon  the  request  of  the  holders 
of  a  certain  proportion  in  amount  of  the  outstand- 
ing bonds,  take  possession  of  the  road  and  operate 
it. 

Railroad  mortgages  frequently  provide  that  the 
bondholders  shall  furnish  the  trustee  with  proper  in- 
demnity against  any  loss  he  may  suffer,  and  against 
any  liability  he  may  incur,  in  the  course  of  his  op- 
eration of  the  road.  It  will  be  remembered  that  the 
trustee  is  personally  liable  to  third  persons  for  the 
misconduct  or  negligence  of  his  employees  and  other 
representatives  in  the  course  of  the  operation  of  the 
road  by  him;  his  liability  to  the  bondholders  is  usu- 
ally limited  by  the  terms  of  the  mortgage  to  his  own 
wilful  wrongdoing  or  gross  negligence. 

While  in  control  and  operation  of  the  road  the 


156  RAILROAD  BONDS  AND  NOTES 

trustee  occupies  a  position  of  trust  towards  the  rail- 
road company  and  owes  it  duties  equally  as  delicate 
as  he  does  the  bondholders. 

A  trustee  operating  the  road,  generally  speaking, 
takes  the  place  of  the  railroad  company.  He  suc- 
ceeds to  all  its  rights  and  is  charged  with  all  its  lia- 
bilities incident  to  the  operation  of  the  road  under 
its  franchise.  He  is  entitled  to  immediate  posses- 
sion for  that  purpose.  Should  the  railroad  company 
refuse  to  surrender  the  mortgaged  property  to  him 
after  proper  demand,  the  court  will  compel  it  to  do 
so.  The  court  will  also  compel  the  railroad  com- 
pany to  account  to  the  trustee  for  all  income  received 
by  it  during  the  time  the  trustee  was  wrongfully 
kept  out  of  possession. 

The  income  that  the  road  earns  during  the  period 
the  trustee  operates  it,  and  the  proceeds  of  any  lease 
or  sale  of  the  property,  must  be  accounted  for  by  him 
to  the  bondholders  and  all  others  interested. 

The  distribution  of  the  monies  the  trustee  receives 
in  the  course  of  his  possession  and  operation  of  the 
road  or  from  any  lease  of  it  is  regulated  by  the  mort- 
gage that  confers  such  power  to  operate  or  to  lease. 
The  usual  order  of  distribution  is :  that  he  retain  the 
expenses  of  the  trusteeship,  including  his  own  com- 
pensation and  fees  for  legal  counsel ;  that  he  pay  the 
expenses  of  the  management  of  the  road  during  his 
possession  and  the  cost  of  all  repairs  needed  to  keep 
it  in  good  working  condition;  that  he  then  pay  such 


FORECLOSING  THE  MORTGAGE          157 

claims  under  liens  having  priority  over  his  mortgage 
in  the  order  of  their  respective  priorities;  and  that 
then  to  the  payment  of  the  sums  due  under  his  mort- 
gage he  apply  what  he  then  has  on  hand;  and  the 
balance,  if  any,  he  shall  turn  over  to  the  railroad 
company. 

With  respect  to  the  payment  of  the  principal  of 
the  bonds  under  his  mortgage,  if  it  be  not  yet  ma- 
tured nor  declared  to  be  due,  then  the  trustee  first 
pays  the  over-due  interest,  with  interest  on  the  de- 
layed interest.  If  the  principal  of  the  bonds  be 
due,  or  declared  due,  then  he  shall  pay  such  principal 
with  interest  thereon,  with  interest  on  the  delayed 
interest,  ratably  without  any  discrimination  as  be- 
tween principal  and  interest  and  interest  on  delayed 
interest. 

Should  any  question  arise  as  to  the  proper  distri- 
bution of  the  monies  in  the  hands  of  the  trustee,  he 
seeks  the  advice  and  protection  of  the  court,  and 
pays  out  only  under  its  direction. 

Upon  taking  possession  of  the  road  for  the  pur- 
pose of  operating  it  under  the  mortgage,  the  trustee 
should  immediately  inform  himself  fully  of  the  ex- 
tent of  the  property  that  has  come  under  his  charge 
and  its  condition;  what  is  necessary  for  its  operation, 
how  it  can  be  best  preserved  and  what  can  be  dis- 
pensed with  without  imperiling  the  security.  He  is 
bound  to  see  that  the  property  is  not  allowed  to  rust 
in  disuse  or  depreciate  in  value.  He  must  get  the 


158  RAILROAD  BONDS  AND  NOTES 

road  and  the  mortgaged  property  in  such  condition 
as  will  make  it  most  productive  and  most  likely  to 
discharge  the  obligations  it  must  meet.  To  this  end 
the  trustee  is  entitled  to  incur  necessary  expenses. 
The  law  gives  a  preference  to  these  indebtednesses 
necessarily  incurred  by  the  trustee  to  preserve  the 
property  and  the  value  of  the  franchise.  They  are 
entitled  to  be  paid  before  the  bondholders  under  the 
mortgage  receive  anything  for  either  interest  or  prin- 
cipal of  their  bonds. 

The  trustee  while  in  operation  and  possession  of 
the  road  may  make  all  those  contracts  that  are  inci- 
dental to  the  operation  of  a  railroad. 

To  operate  a  railroad  the  trustee  must  necessarily 
employ  help,  make  repairs,  purchase  supplies  and 
materials,  and  make  the  many  other  contracts  inci- 
dental to  carrying  out  the  duties  he  has  assumed. 
With  regard  to  these  details  of  management  the  trus- 
tee may  act  generally  as  the  railroad  company  might 
have  done  had  it  continued  in  control. 

But  contracts  of  the  railroad  while  it  was  in  pos- 
session and  operation,  and  before  the  trustee  took 
control,  are  not  binding  on  the  trustee  unless  the 
mortgage  makes  them  so  or  the  trustee  chooses  to  ac- 
cept and  adopt  them. 

In  a  number  of  States  there  are  statutes  regulating 
the  duties  and  obligations  and  rights  of  a  trustee  on 
taking  possession  of  a  railroad  under  a  mortgage  and 
operating  it.  These  statutes  become  part  of  the 


FORECLOSING  THE  MORTGAGE          159 

mortgage  with  the  same  effect  as  if  set  forth  therein 
at  length. 

In  operating  the  road  it  is  the  duty  of  the  trustee 
to  employ  persons  competent  to  perform  the  work  to 
which  they  are  assigned.  He  is  answerable  for  the 
neglect  of  his  employees  when  they  are  acting  within 
the  scope  of  their  respective  employments.  He  is 
personally  liable;  there  is  no  official  liability,  as  in 
the  case  of  a  receiver,  because  the  trustee  is  not  the 
officer  of  the  court  as  is  the  receiver.  He  is  the  rep- 
resentative of  the  parties  to  the  mortgage  and  chosen 
by  them.  The  receiver  represents  the  court  that  ap- 
pointed him. 

The  usual  form  of  mortgage,  however,  provides 
that  should  the  trustee  be  held  liable  for  injuries  to 
persons  or  property  caused  by  the  negligence  of  him- 
self or  his  employees  in  the  course  of  the  manage- 
ment and  operation  of  the  road,  he  shall  be  reim- 
bursed out  of  the  mortgaged  property  for  monies  he 
may  have  paid  out  for  damages  and  for  any  liability 
he  may  have  incurred.  In  some  of  the  mortgages, 
provision  is  contained  that  before  the  trustee  shall 
be  required  to  take  possession  and  operate  the  road, 
he  shall  be  furnished  by  the  bondholders  with  a 
proper  and  sufficient  indemnity  against  any  loss  he 
may  suffer  or  liability  he  may  incur  in  the  course  of 
such  operation. 

Some  of  the  States  have  statutes  relieving  trustees, 
operating  a  railroad,  from  personal  liability  for  in- 


160  RAILROAD  BONDS  AND  NOTES 

juries  caused  by  the  negligence  of  employees.  They 
make  him,  like  receivers,  officially  liable  only;  that 
is,  the  recovery  of  damages  in  such  a  case  is  limited 
to  the  property  in  his  control.  In  the  absence  of 
such  a  statute  he  is  personally  liable. 

Most  mortgages  provide  that  should  the  trustee 
become  liable  for  the  payment  of  any  damages,  or 
incur  any  liability,  in  the  course  of  his  trusteeship, 
whether  in  the  operation  of  the  road  or  otherwise, 
he  shall  be  reimbursed  by  the  railroad  company; 
and  that  should  the  railroad  company  not  pay  him 
nor  indemnify  him,  then  that  such  sums  shall  be  paid 
to  him  out  of  the  trust  property,  in  the  safeguard- 
ing and  management  of  which  he  has  become  thus 
liable. 

Trustee  selling  the  mortgaged  property  to  satisfy 
claims  under  his  mortgage;  exercise  of  this 
power  may  be  within  the  discretion  of  trustee 
or  controlled  by  bondholders;  details  of  such 
sale. 

Upon  default  by  the  railroad  company,  the  trus- 
tee is  given  the  power  by  the  usual  form  of  railroad 
mortgage  to  sell  the  mortgaged  road  and  the  other 
mortgaged  property,  and  to  satisfy  out  of  the  pro- 
ceeds what  is  due  under  his  mortgage.  This  power 
must  be  specifically  given  by  the  mortgage;  should 
it  be  silent  on  this  point  the  trustee  does  not  have 
this  power  to  sell. 


FORECLOSING  THE  MORTGAGE          161 

The  trustee  is  usually  permitted  to  sell  with  or 
without  entering  into  possession  of  the  road  and  the 
other  mortgaged  property. 

In  conferring  this  remedy  some  mortgages  say  that 
the  trustee  may  exercise  it  as  in  his  discretion  he  be- 
lieves for  the  best  interests  of  his  bondholders.  In 
other  mortgages  this  power  in  the  trustee  to  sell  is 
made  dependent  upon  the  will  of  the  bondholders 
and  the  trustee  may  only  sell  when  requested  by  the 
holders  of  a  certain  specified  proportion,  in  amount, 
of  the  outstanding  bonds. 

Should  the  trustee  sell  the  mortgaged  property 
without  proper  authority,  he  renders  himself  liable 
to  the  bondholders  for  any  damage  they  may  suffer 
as  a  result  of  his  act. 

The  sale  under  this  power  must  be  made  at  pub- 
lic auction.  The  property  is  sold  to  the  highest  bid- 
der. Notice  of  the  sale  is  given  by  a  series  of  ad- 
vertisements in  newspapers.  The  amount  and  na- 
ture of  the  advertising  and  all  the  details  with  re- 
spect to  the  salj  are  regulated  in  the  mortgage. 

The  proceeds  of  the  sale  are  applied  by  the  trus- 
tee as  provided  in  the  mortgage,  which  is  substan- 
tially in  the  same  order  as  the  rentals  and  other  in- 
come received  by  him  during  his  possession  and  op- 
eration. That  is,  he  pays  the  costs  and  expenses  of 
the  sale  and  of  his  trusteeship,  including  his  own 
compensation  and  fees  for  legal  counsel ;  then  he  ap- 
plies the  balance  to  the  payment  of  the  principal  and 


162  RAILROAD  BONDS  AND  NOTES 

interest  with  interest  on  the  delayed  interest  of  the 
bonds  under  his  mortgage.  Any  surplus  remaining 
is  turned  over  to  the  railroad  company.  Should 
there  be  prior  liens  against  the  property,  the  prop- 
erty may  be  sold  subject  to  those  liens,  in  which  case 
the  purchaser  takes  the  property  charged  with  their 
payment ;  or  the  property  may  be  sold  free  and  clear 
of  such  prior  liens,  in  which  case  they  will  be  paid 
out  of  the  proceeds  of  the  sale.  All  liens  entitled 
to  priority  over  that  of  the  mortgage,  are  paid  in  full 
before  the  claims  under  the  mortgage  receive  any- 
thing. 

The  two  remedies,  just  treated,  of  either  selling  the 
road  or  operating  it  and  then  selling,  if  necessary, 
are  quite  generally  contained  in  railroad  mortgages, 
but  are  not  often  exercised  by  the  trustee,  as  each 
imposes  upon  him  many  new  duties  and  new  responsi- 
bilities. Trustees,  therefore,  usually  place  the  en- 
tire matter  before  the  court  by  bringing  an  action  to 
foreclose  the  mortgage.  In  this  action  of  foreclosure 
the  trustee  asks  the  court  to  appoint  a  receiver  to 
operate  the  road  and  sell  it  under  its  direction,  and 
thus  relieves  himself  of  the  responsibilities  that  are 
incident  to  the  operation  and  sale  of  the  road  by  him. 

Foreclosure;  outline  of  procedure. 

Foreclosure  of  a  railroad  mortgage  means  that  the 
mortgaged  road,  and  all  the  other  property  covered 


FORECLOSING  THE  MORTGAGE          163 

by  the  mortgage,  and  all  the  rights  of  the  various  par- 
ties in  any  way  affecting  it,  are  brought  before  the 
court.  The  court  then  assumes  control  and  admin- 
isters the  property.  It  ascertains  and  determines  the 
rights  of  all  the  parties  who  in  the  end  may  be  found 
to  have  any  interest  in  that  property  before  the 
court. 

The  court  takes  physical  possession  of  this  prop- 
erty by  means  of  a  receiver.  The  receiver  enters  into 
possession  of  and  holds  the  property  thus  given  into 
his  charge ;  or,  if  the  court  deem  it  advisable,  it  orders 
the  receiver  to  operate  the  road  under  its  direction. 

The  foreclosure  action  then  progresses  through  the 
different  stages  of  practice  and  procedure  until  the 
decree  of  foreclosure  is  reached.  This  decree  of 
foreclosure  states  the  amount  the  court  has  found  to 
be  due  under  the  mortgage  and  orders  that  the  rail- 
road company  pay  it  within  a  specified  time  and  in 
case  of  its  failure  to  do  so,  directs  that  the  mortgaged 
property  be  sold  to  satisfy  the  sum  so  found  due. 
The  decree  further  orders  the  distribution  of  the  pro- 
ceeds of  the  sale.  After  the  sale  a  final  decree  is 
signed  by  the  court  confirming  what  has  been  done. 

The  property  is  usually  bought  in  at  the  fore- 
closure sale  by  a  combination  formed  by  the  holders 
of  the  bonds  under  the  foreclosed  mortgage,  in  which 
the  holders  of  other  issues  or  the  stockholders  may 
join. 


164  RAILROAD  BONDS  AND  NOTES 

Foreclosure  by  trustee  generally;  may  be  con- 
trolled by  bondholders ;  rights  of  majority  and 
minority;  foreclosure  by  bondholders  instead 
of  trustee. 

The  trustee,  ordinarily,  is  the  party  to  foreclose 
the  mortgage.  He  is  the  mortgagee:  the  mortgage 
is  made  to  him. 

In  foreclosing  the  mortgage  the  trustee  does  so  for 
the  benefit  of  all  the  bondholders  secured  by  that 
mortgage.  He  represents  them  all  and  they  are  not 
entitled  to  be  made  parties  to  the  action  and  appear 
before  the  court  unless  their  interests  are  endangered 
by  some  wrongful  act  of  the  trustee. 

The  power  of  the  trustee  to  foreclose  is  sometimes 
qualified  by  the  mortgage.  The  usual  qualification 
in  this  regard  is  that  he  shall  foreclose  only  upon  the 
request  of  the  holders  of  a  designated  amount,  usu- 
ally a  majority,  of  the  outstanding  bonds,  and  when 
so  requested  he  shall  foreclose.  He  may  not  fore- 
close unless  thus  requested;  and  when  thus  requested 
he  must  foreclose. 

When  no  such  qualification  exists,  and  he  is  not 
taking  possession  of  the  road  to  operate  or  sell  it,  he 
must  proceed  to  foreclose  when  requested  by  a  mi- 
nority even  against  the  protests  of  a  majority.  So 
long  as  there  are  some  bondholders,  under  the  condi- 
tions stated,  who  desire  to  foreclose,  he  must  do  so, 
when  he  is  not  pursuing  other  remedies  under  the 
mortgage.  The  majority,  under  these  conditions, 


FORECLOSING  THE  MORTGAGE          165 

have  their  remedy.  They  may  demand  that  the 
trustee  take  possession  and  operate  the  road,  or  sell 
it,  should  that  power  be  conferred  on  him  by  the 
mortgage  and  they  have  the  requisite  holdings  under 
the  mortgage  necessary  to  enforce  such  demand. 
They  may  not  refuse,  however,  to  enforce  their  rem- 
edies and  interfere  with  others  enforcing  theirs. 

The  trustee,  when  the  railroad  company  defaults, 
must  act ;  he  must  pursue  some  remedy  that  the  mort- 
gage or  the  law  gives  him.  He  may  not  stand  inac- 
tive, even  at  the  request  of  the  majority.  The  trus- 
tee represents  all  the  holders  of  the  outstanding 
bonds  of  that  issue  and  not  a  portion,  even  though 
that  portion  be  a  majority.  He  must  proceed  to 
protect  all  his  bondholders  and  to  realize  on  the  se- 
curity for  them. 

Should  a  majority  desire  that  the  trustee  do  noth- 
ing; that  he  neither  take  possession  of  the  road,  un- 
der the  mortgage,  and  operate  it  or  sell  it,  nor  that  he 
foreclose  the  mortgage,  they  may  stop  proceedings 
only  by  satisfying  the  claims  of  the  minority  by  pay- 
ing the  value  of  their  bonds  with  interest  and  the 
costs  of  the  suit  already  incurred. 

There  are  circumstances  when  the  bondholders  in- 
stead of  the  trustee  may  foreclose  the  mortgage. 
Generally,  this  is  when  the  trustee  has  refused  or 
neglected  to  do  so  after  having  been  properly  re- 
quested; or  when  he  is  not  acting  in  good  faith;  or 
when  he  is  not  properly  protecting  the  interests  of 


166  RAILROAD  BONDS  AND  NOTES 

the  bondholders;  or  when  he  has  acquired  interests 
that  are  antagonistic  to  those  of  the  bondholders; 
or  when  he  occupies  a  hostile  position  toward  them. 
And  should  the  trustee  have  commenced  the  fore- 
closure, the  court  will  permit  the  bondholders  to 
come  in  and  prosecute  the  suit,  and  displace  him, 
when  sufficient  reasons  along  the  lines  indicated  ap- 
pear to  its  satisfaction. 

Should  there  be  a  vacancy  in  the  trusteeship  the 
bondholders  foreclose. 

Bondholders,  by  a  provision  in  the  mortgage,  often 
agree  that  they  shall  not  foreclose  the  mortgage  but 
that  the  right  to  do  so  shall  vest  absolutely  in  the 
trustee.  Notwithstanding  this  provision,  the  bond- 
holders may  foreclose  the  mortgage  themselves,  when 
the  trustee  has  lost  his  right  to  do  so  by  his  bad 
faith,  opposing  interests,  antagonistic  attitude,  or  in 
any  other  way  not  properly  protecting  their  rights. 

When  bondholders  foreclose  the  mortgage,  instead 
of  the  trustee,  they  act  for  themselves  and  all  the 
other  bondholders  secured  by  that  mortgage.  All 
bondholders  secured  by  the  same  mortgage  have  a 
common  interest  in  the  security.  What  benefits  one 
inures  to  the  benefit  of  all  as  a  class.  The  court  pro- 
tects the  rights  of  all  bondholders  though  not  ap- 
pearing personally  in  the  action  which  has  been 
brought  by  one  or  more  of  their  number  in  behalf  of 
all.  The  other  bondholders,  however,  may  come  in 
and  be  made  parties  to  the  action  should  they  so  de- 


FORECLOSING  THE  MORTGAGE  167 

sire.  See  Litigation  is  conducted  by  the  trustee,  etc. 
Page  126.  Also  see  Bondholders  may  conduct  liti- 
gation instead  of  trustee.  Page  128. 

When  foreclosure  sale  had. 

It  may  be  said  that,  as  a  general  rule,  a  foreclosure 
sale  will  not  be  ordered  until  toward  the  end  of  the 
action,  when  all  the  rights  and  priorities  of  the  par- 
ties in  the  property  have  been  decided  by  the  court. 
But  when  the  property  is  in  such  condition  that  it 
may  seriously  depreciate  in  value  during  the  progress 
of  the  foreclosure,  and  there  is  no  available  money  to 
put  it  in  repair  and  properly  maintain  it,  the  court 
may  order  it  sold  immediately  or  as  soon  as  circum- 
stances justify.  However,  to  sell  the  property  be- 
fore the  rights  of  the  parties  and  all  contests  and 
disputes  have  been  settled  is  unusual  and  will  not  be 
done  unless  special  circumstances  make  it  necessary. 

Entire  road  sold  as  one  instead  of  in  separate  par- 
cels; foreclosure  for  interest;  lease  instead  of 
sale ;  when  divisions  are  separately  mortgaged ; 
mortgages  on  constituent  roads  of  consolidated 
company. 

The  road  and  the  other  property  included  in  the 
mortgage  is  sold,  as  a  general  rule,  in  its  entirety  as 
one  lot.  This  is  because  railroad  property  can  rarely 
be  divided  into  parcels  and  sold  separately  without 
injury  to  the  road  as  a  working  unit.  Each  part 


168  RAILROAD  BONDS  AND  NOTES 

depends  for  its  value  in  a  great  measure  upon 
the  existence  and  cooperation  of  the  others  and 
all  depend  for  their  fullest  value  upon  their  con- 
certed and  active  use.  If  the  unity  of  the  road 
be  maintained  so  that  a  purchaser  at  the  foreclosure 
sale  is  in  a  position  to  continue  it  as  a  going  concern, 
it  will  influence  the  price  advantageously;  indeed, 
it  is  doubtful  if  any  bid  worth  considering  would  be 
made  if  the  road  were  not  in  the  condition  that  it 
could  be  operated  immediately  upon  purchase. 

If  the  property  be  capable  of  division  without  in- 
jury, it  may  be  sold  in  separate  parcels. 

Where  the  mortgage  is  foreclosed  for  failure  to 
pay  an  instalment  of  interest,  then  only  so  much  of 
the  mortgaged  property  as  will  satisfy  the  claim  for 
interest  will  be  sold  if  the  property  may  be  divided 
without  injury.  But  if  the  property  cannot  be  di- 
vided without  injury  it  will  be  sold  together. 

There  are  times  when  a  sale  of  the  mortgaged 
property  would  work  an  unnecessary  injury  to  the 
railroad  company  and  its  other  creditors  without 
gaining  anything  thereby  to  the  bondholders.  The 
claims  of  the  bondholders  may  be  satisfied,  perhaps, 
without  the  disorganization  of  the  railroad  company 
and  the  needless  sacrifice  of  property  that  the  fore- 
closure may  result  in.  This  is  attempted  by  means 
of  a  lease.  The  road  is  leased  to  one  or  more  per- 
sons, or  a  corporation,  who  take  it  over  and  work  it, 
paying  therefor  a  stipulated  rental.  This  rental  is 


FORECLOSING  THE  MORTGAGE          169 

paid  to  the  trustee  and  is  applied  to  the  satisfaction 
of  the  claims  under  the  mortgage.  The  court  orders 
the  lease  for  the  shortest  period  that  will  produce 
enough  money  to  meet  the  claims  against  it.  In  the 
lease  precaution  is  taken  against  the  lessee  neglecting 
the  property.  The  lessee  is  usually  required  to  give 
security  that  he  will  keep  the  road  in  good  repair  and 
condition  during  the  term  of  the  lease. 

Leasing  is  resorted  to  when  the  value  of  the  prop- 
erty is  greatly  in  excess  of  the  amount  for  which  the 
foreclosure  is  brought,  as  when  the  action  is  for  de- 
faulted interest  only. 

Bondholders  may  be  secured  by  a  mortgage  on  one 
part  or  division  of  a  road.  They  then,  of  course, 
have  no  interest  in  mortgages  covering  other  parts  or 
divisions.  They  are  limited  to  the  division  that 
their  mortgage  covers.  But  cases  do  arise  where  sev- 
eral divisions  have  been  separately  mortgaged  and 
all  the  mortgages  foreclosed  at  the  same  time ;  or  two 
or  more  roads  may  have  consolidated,  having  mort- 
gages on  each  constituent  road  and  then  these  mort- 
gages may  be  foreclosed  at  the  same  time.  In  such 
cases  the  court  may  order  a  sale  of  the  entire  road 
and  then  adjust  the  claims  of  the  bondholders  under 
these  several  mortgages  upon  the  proceeds. 

The  claims  of  the  several  classes  of  bondholders 
under  their  separate  mortgages  are  adjusted  accord- 
ing to  the  value  of  the  part  or  division  of  the  road 
upon  which  they  had  their  respective  mortgages.  But 


iyo  RAILROAD  BONDS  AND  NOTES 

this  is  not  the  general  rule  and  the  entire  property 
is  sold  only  when  a  sale  of  each  division  under  each 
mortgage  would  be  harmful  to  the  entire  property. 
Bondholders  under  each  foreclosed  mortgage  are  en- 
titled to  sell  the  property  or  division  covered  by  their 
respective  mortgages  without  being  involved  in  any 
other  foreclosure  unless  an  unusual  situation  is  pre- 
sented. The  courts  realize  that  the  sale  of  a  system 
as  an  entirety,  under  these  circumstances,  would  in- 
terfere with  the  opportunity  of  the  bondholders  un- 
der each  mortgage  to  combine  to  protect  their  se- 
curity without,  perhaps,  burdening  themselves  with 
handling  the  entire  road.  Therefore,  when  there  are 
separate  mortgages  against  separate  divisions,  each 
division  will  be  sold  separately  to  satisfy  the  claims 
against  it  unless  this  cannot  be  done  without  injury; 
then  the  court  will  order  that  all  be  sold  together 
and  adjust  the  claims  of  the  several  mortgages  upon 
the  proceeds. 

Reasons  for  combinations  to  purchase;  combina- 
tions of  bondholders  and  others ;  rights  of  non- 
participating  bondholders. 

Every  effort  should  be  made  to  get  the  best  price 
for  the  mortgaged  road  that  is  to  be  sold.  And  the 
court  will  aid  any  endeavor  in  that  direction. 

The  amount  involved  is  usually  too  large  for  in- 
dividual enterprise.  And  it  is  the  custom,  and  al- 
most necessarily  so,  for  the  bondholders  under  the 


FORECLOSING  THE  MORTGAGE          171 

foreclosed  mortgage,  with  or  without  others,  to  com- 
bine to  purchase  and  to  reorganize  railroad  property 
when  sold  under  foreclosure.  Without  such  com- 
binations, the  number  of  bidders  would  be  very  lim- 
ited and  take  away  to  a  great  extent  the  competitive 
bidding  necessary  to  prevent  a  sacrifice  of  property. 
For  the  bondholders  to  combine  in  this  way  is  only 
what  prudent  men  should  do  to  protect  their  security. 
The  course  by  which  the  bondholders  unite  is  to  en- 
ter into  an  agreement  among  themselves,  pursuant 
to  which  their  bonds  are  deposited  with  a  committee 
for  the  purpose  of  purchasing  the  road.  The  com- 
mittee accordingly  purchases  the  road,  organizes  a 
new  corporation  to  take  over  and  operate  the  road  so 
purchased. 

When  these  combinations  are  properly  entered 
into  and  without  any  intention  to  defraud  any  party 
in  interest,  they  are  favored  by  the  courts.  The 
legislatures  of  many  of  the  States  have  enacted  laws 
regulating  the  taking  possession  of  railroad  property 
by  persons  who  have  combined  and  purchased  it  at 
a  foreclosure  sale.  Generally,  these  statutes  author- 
ize the  purchasers  of  a  railroad  at  a  foreclosure  sale 
to  reorganize  as  a  new  corporation  and  to  operate  the 
property  so  purchased  with  the  franchise  of  the  old 
company.  These  statutes,  in  some  of  the  States, 
create  the  purchasers  of  railroad  property  at  a  fore- 
closure sale  into  a  corporation  without  any  formal 
act  on  their  part.  The  mere  fact  that  they  have 


172  RAILROAD  BONDS  AND  NOTES 

purchased  the  railroad  property  at  foreclosure  sale 
constitutes  them  a  corporation  under  these  statutes. 
Bondholders  who  have  not  joined  in  the  purchas- 
ing combination  are  entitled  to  their  proportionate 
shares  of  the  proceeds  of  the  sale;  and  they  may 
compel  the  newly  organized  corporation  to  account 
to  them  for  any  property  it  may  have  received  from 
the  old  railroad  company,  when  there  is  any  question 
as  to  whether  they  have  received  all  they  are  enti- 
tled to  or  not.  See  Chap.  VIII.  Rights  and  Rem- 
edies with  Relation  to  the  Reorganization  of  the 
Railroad  Company.  Page  335. 

Persons  barred  from  purchasing  at  the  foreclosure 
sale ;  persons  who  may  purchase. 

The  trustee  is  not  permited  to  purchase  the  mort- 
gaged property  in  his  own  behalf,  without  being 
liable  to  account  to  his  bondholders  therefor.  It  is 
rudimentary  in  the  law  that  one  occupying  a  position 
of  trust  and  confidence  toward  property  may  not 
purchase  that  property  in  his  own  behalf.  The  trus- 
tee, however,  is  very  often  authorized  by  the  mort- 
gage to  purchase  at  the  foreclosure  sale  on  behalf  of 
the  bondholders  at  their  request:  he  may  then  do  so. 

As  a  rule  any  one  may  purchase  at  the  foreclosure 
sale  whose  relations  to  the  property  is  not  one  of 
trust  and  confidence.  The  president  of  the  road 
may  purchase  as  an  individual  when  there  is  no 
fraud  or  unfairness.  The  attorney  for  the  road  may 


FORECLOSING  THE  MORTGAGE          173 

purchase  and  take  title  to  the  property  at  foreclosure 
for  the  benefit  of  the  bondholders,  at  their  request. 
A  director  of  the  railroad  company,  however,  occu- 
pies a  position  of  trust  toward  it  and  he  may  not, 
therefore,  purchase  as  an  individual  without  permis- 
sion of  the  court  or  the  railroad  company. 

Bondholders  may  purchase  for  themselves.  Or- 
dinarily, they  are  the  most  likely  purchasers,  because 
they  need  not  pay  their  bid  in  cash. 

Rights  of  purchasers;  title  acquired;  franchise  to 
operate ;  distinction  pointed  out. 

The  purchaser  at  the  foreclosure  sale,  generally 
speaking,  takes  whatever  rights  the  trustee  and  the 
railroad  company  had  in  the  property  covered  by  the 
mortgage.  The  decree  of  sale  specifies  the  property 
and  the  interest  in  it  that  is  to  be  sold;  it  must  not 
include  anything  not  covered  by  the  mortgage. 

The  franchise  to  operate  the  road  does  not  pass 
to  the  purchaser  unless  it  was  included  in  the  mort- 
gage and  the  decree  of  sale.  However,  it  is  included 
in  railroad  mortgages,  quite  generally,  to  enable  the 
purchaser  to  continue  the  road  in  operation.  The 
franchise  cannot  be  used  without  a  road;  and  a  road 
cannot  be  used  lawfully,  as  against  the  state,  without 
a  franchise.  Each  loses  value  without  the  other; 
therefore  the  franchise  to  operate  is  usually  included 
in  railroad  mortgages,  so  as  to  give  a  value  to  the 
physical  property  of  the  road.  Those  statutes,  as 


174  RAILROAD  BONDS  AND  NOTES 

previously  mentioned,  which  constitute  the  pur- 
chaser of  railroad  property  at  a  foreclosure  sale 
into  a  corporation  do  not  confer  on  them  the  fran- 
chise to  operate  the  road;  that  must  be  included  in 
the  mortgage  and  purchased  at  the  foreclosure  sale. 

When  the  franchise  to  operate  is  included  in  the 
sale,  the  purchaser  acquires  all  the  rights  the  railroad 
company  had  to  operate  the  road. 

It  is  not  necessary  that  a  corporation  should  pur- 
chase the  road  or  that  persons  who  have  purchased 
should  incorporate  in  order  to  operate  it.  The  fran- 
chise to  operate  the  road  may  be  exercised  by  indi- 
viduals. The  custom,  however,  is  that  a  corpora- 
tion shall  operate  the  road. 

That  individuals,  as  such,  and  without  incorporat- 
ing, may  operate  a  railroad,  demonstrates  sharply 
the  difference  between  the  franchise  of  the  company 
to  exist  as  a  corporation  and  its  franchise  to  operate 
the  road.  The  franchise  to  operate  the  road  is  a 
special  privilege  granted  by  the  State.  It  is  usually 
granted  to  a  corporation  already  in  existence  and 
already  exercising  its  franchise  to  exist  as  a  corpora- 
tion. 

The  franchise  to  operate  the  road  between  certain 
terminii  and  over  certain  territory  to  the  exclusion  of 
all  others  is  owned  by  the  corporation  just  as  it  owns 
any  other  piece  of  property. 

The  franchise  to  exist  as  a  corporation  is  also  a 
privilege  granted  by  the  State,  but  it  is  a  distinct  and 


FORECLOSING  THE  MORTGAGE          175 

separate  privilege  from  the  franchise  to  operate  a 
railroad.  As  was  seen,  the  corporation  may  be  in 
existence  under  its  franchise  to  be  a  corporation  be- 
fore it  receives  its  franchise  to  operate  a  railroad; 
and  the  railroad  company  may  continue  in  existence 
as  a  corporation  after  it  has  lost  the  franchise  to 
operate  the  road  by  reason  of  its  sale  at  foreclosure. 
In  fact  a  railroad  corporation  after  it  has  been 
stripped  of  all  its  property,  including  its  franchise  to 
operate  the  road,  continues  in  existence  until  dis- 
solved by  legal  proceedings  to  which  the  attorney 
general,  representing  the  State,  is  a  party. 

The  purchaser  of  the  franchise  to  operate  the  road 
does  not  by  reason  of  that  purchase  acquire  the  right 
or  franchise  to  be  a  corporation,  unless  some  statute 
expressly  makes  such  purchasers  a  corporation  by 
reason  of  such  purchase. 

The  legislatures  of  many  of  the  States  have  en- 
acted laws  providing  for  purchasers  of  railroad  prop- 
erty at  foreclosure  sales  to  become  incorporated  for 
the  purpose  of  taking  over  the  property  and  operat- 
ing it.  In  some  of  the  States  these  statutes  en- 
able such  purchasers  to  become  a  corporation  im- 
mediately upon  taking  over  the  property.  Some 
of  these  statutes  declare  that  the  new  corporation 
so  created  shall  have  all  the  privileges,  and  be 
charged  with  all  the  obligations  of  the  old  company 
relating  to  the  operation  and  the  maintenance  of 
the  railroad. 


176  RAILROAD  BONDS  AND  NOTES 

Standing  of  purchaser  at  foreclosure  sale. 

The  purchaser  at  the  foreclosure  sale  makes  him- 
self a  party  to  the  legal  proceedings  which  relate  to 
the  sale  to  the  extent  that  the  court  may  compel  him 
in  those  proceedings  to  carry  out  his  purchase.  At 
the  same  time  he  becomes  entitled  to  be  heard  before 
the  court  in  the  foreclosure  proceedings  on  all  mat- 
ters which  in  any  way  affect  his  bid  or  his  liability 
as  a  purchaser. 

Liability,  if  any,  of  purchaser  or  new  corporation 
for  debts  and  contracts  of  the  railroad  com- 
pany; for  mortgages  and  other  liens  against 
the  property;  sale  subject  to  or  free  of  such 
mortgages  or  other  liens;  transferring  liens 
to  proceeds  of  sale. 

The  purchaser  at  the  foreclosure  sale  does  not  be- 
come liable,  by  his  acquisition  of  such  property,  for 
the  debts  or  contracts  of  the  railroad  company.  Nor 
does  the  new  corporation  which  is  formed  and  takes 
over  the  road  become  liable  for  the  debts  or  con- 
tracts of  the  old  company  because  it  succeeds  it. 

However,  if  the  debts  or  contracts  or  mortgages  of 
the  old  insolvent  railroad  company  are  liens  on  the 
mortgaged  property  sold,  having  priority  over  the 
lien  of  the  foreclosed  mortgage,  the  purchaser  may 
take  the  property  subject  to  such  liens.  Then  the 
purchaser  must  satisfy  such  liens  but  only  to  the 


FORECLOSING  THE  MORTGAGE          177 

extent  that  the  property  against  which  they  are  a  lien 
will  do  so.  Beyond  that  there  is  no  liability. 

The  property  may  be  sold  free  and  clear  of  all 
such  prior  mortgages  and  other  liens.  Their  liens 
are  then  transferred  to  the  proceeds  of  the  sale. 
Under  these  circumstances  the  purchaser  takes  the 
property  without  any  burdens  as  to  such  liens.  This 
enables  him  to  get  the  road  and  operate  it  unem- 
barrassed by  any  incumbrances,  but  requires  more 
money  as  the  purchaser  must  then  pay  the  entire 
price. 

Should  the  purchaser  take  the  property  subject  to 
prior  liens,  immediate  money  for  their  satisfaction 
may  not  be  needed,  as  they  may  not  be  due  for  some 
time,  or  if  due,  provision  may  be  made  for  their  pay- 
ment at  some  time  in  the  future. 

Purchasers  as  affected  by  debts,  contracts,  and  cer- 
tificates of  receiver. 

The  mortgaged  property  is  also  sold,  quite  gen- 
erally, free  from  the  lien  of  the  receiver's  certificates 
and  the  lien  thereof  is  transferred  to  the  proceeds  of 
the  sale.  The  property,  however,  may  be  sold  sub- 
ject to  the  lien  of  the  receiver's  certificates,  whereupon 
the  purchaser  must  pay  them  to  the  extent  that  the 
property  against  which  they  were  charged  will  do  so. 
That  is,  his  liability  is  limited  to  the  property  pur- 
chased; there  is  no  personal  responsibility  or  liabil- 


178  RAILROAD  BpNDS  AND  NOTES 

ity  after  such  property  has  been  exhausted  for  that 
purpose.  This  matter  is  always  taken  care  of  by 
the  decree  of  the  court  which  fixes  the  terms  of  the 
sale  and  the  conditions  under  which  the  property 
shall  be  sold. 

The  purchaser  at  the  foreclosure  sale  takes  the 
property  free  from  the  debts  of  the  receiver,  except 
such  as  may  be  specifically  charged  against  such  prop- 
erty, as  receiver's  certificates  usually  are. 

The  contracts  that  the  receiver  made  during  his 
receivership  are  not  binding  on  the  purchaser  at  the 
foreclosure  sale  unless  he  chooses  to  accept  and  adopt 
them.  He  is  at  liberty  to  reject  any  or  all  contracts 
made  by  the  receiver  and  to  refuse  to  be  affected  by 
them,  or  some  of  them;  or  he  may  accept  them,  or 
some  of  them,  and  make  them  his  own  with  the  same 
force  as  if  he  had  made  them  himself. 

Effect  of  foreclosure  on  claims  of  general  or  unse- 
cured creditors;  on  subsequent  mortgages  or 
other  liens;  on  claims  of  the  foreclosing  bond- 
holders; on  prior  mortgages  or  other  liens; 
certain  liens  having  priority ;  equity  of  redemp- 
tion. 

The  foreclosure  sale  cuts  off  the  claims  of  general 
or  unsecured  creditors  so  far  as  the  property  involved 
in  the  foreclosure  is  concerned.  Their  claims,  how- 
ever, continue  against  the  railroad  company. 

The    foreclosure    sale    also   cuts    off    all    claims 


FORECLOSING  THE  MORTGAGE          179 

against  the  property  involved  in  the  foreclosure  un- 
der mortgages  or  other  liens  that  attached  to  that 
property  later  than  the  lien  of  the  foreclosed  mort- 
gage. These  claims,  of  course,  continue  against  the 
railroad  company,  but  their  lien  or  special  claim 
against  that  property  is  cut  off. 

The  mortgaged  property  is  sold,  as  a  rule,  free 
from  the  claims  of  the  bondholders  of  the  foreclosed 
mortgage  against  it.  Their  lien  with  relation  to  that 
property  is  transferred  to  the  proceeds  of  its  sale. 

Rights  under  prior  mortgages  or  other  prior  liens 
are  not  affected  by  the  foreclosure  action.  Such 
rights  continue  superior  to  those  under  the  foreclosed 
mortgage.  They  must  be  satisfied  in  full,  so  far  as 
the  property  can  do  so  before  the  bondholders  under 
the  foreclosed  mortgage  receive  anything. 

A  prior  mortgage  or  other  prior  lien  is  one  that 
attached  to  the  property  prior  in  point  of  time  to  the 
foreclosed  mortgage,  or  which  has  been  given  priority 
over  the  latter  by  consent  of  its  bondholders,  or  which 
on  account  of  its  nature  is  made  superior  and  there- 
fore prior  to  it.  The  lien  for  public  taxes,  for  in- 
stance, though  accruing  later  than  the  foreclosed 
mortgage  was  executed  or  took  effect,  is  always  su- 
perior to  such  mortgage  and  is  given  priority  over  it. 
The  lien  of  receiver's  certificates  and  of  claims  for 
operating  expenses  prior  to  the  receivership  may  also, 
by  reason  of  their  nature,  be  given  a  priority,  by 
direction  of  the  court,  over  the  foreclosed  mortgage, 


i8o  RAILROAD  BONDS  AND  NOTES 

though  the  debts  they  represent  may  have  been 
incurred  subsequent  to  the  time  when  the  lien  of  the 
foreclosed  mortgage  attached. 

By  selling  the  property  free  from  the  claims  under 
mortgages  and  other  liens  which  attached  to  the  prop- 
erty subsequent  to  the  foreclosed  mortgage,  and  also 
by  selling  such  property  subject  to  those  mortgages 
and  other  liens  that  attached  thereto  prior  to  the  fore- 
closed mortgage,  the  bondholders  under  the  fore- 
closed mortgage  are  enabled  to  sell  and  realize  upon 
the  property  in  the  condition  it  was  in  when  mort- 
gaged to  them.  But  bondholders  must  always  have 
in  mind  that  the  lien  of  their  mortgage  may  be  super- 
seded by  the  lien  for  public  taxes,  assessments,  and 
other  governmental  charges;  and  that  it  may  be  dis- 
placed by  order  of  the  court  by  claims  for  receiver's 
certificates  and,  sometimes,  by  claims  for  operating 
expenses. 

It  is  quite  generally  the  rule  that  where  real  estate 
has  been  mortgaged  and  the  debtor  defaults,  and  the 
mortgage  is  foreclosed,  he  may  redeem  the  property 
at  any  time  before,  and  in  some  States  within  a  speci- 
fied period  after,  the  sale  by  paying  all  that  is  due  at 
the  time  of  such  redemption.  But  a  sale  under  a 
foreclosure  of  a  railroad  mortgage  cuts  off  this  right 
of  redemption  by  the  railroad  company,  and  the  pur- 
chaser at  the  foreclosure  sale  takes  the  property  free 
from  this  equity  of  redemption,  as  it  is  called,  unless 
a  statute  or  the  decree  of  the  court  reserves  this  right 


FORECLOSING  THE  MORTGAGE          181 

to  the  railroad  company.     See  Waiving  redemption 
laws,  etc.    Page  88. 

Time  and  place  of  sale;  notice  of  sale;  adjourn- 
ment. 

The  time  when  and  the  place  where  the  sale  shall 
be  had  are  fixed  by  the  court  in  its  decree  of  sale. 
These  matters  rest  largely  in  the  discretion  of  the 
court. 

In  appointing  a  time  for  the  sale  of  railroad  prop- 
erty, the  court  takes  into  consideration  the  condition 
of  the  finances  of  the  country  and  may  postpone  a 
sale  until  better  results  are  more  likely. 

The  property  is  sold  at  public  auction  unless  the 
court  shall  otherwise  direct.  The  court  may  order 
the  property  sold  at  private  sale ;  but  before  doing  so 
it  requires  that  it  be  fully  informed  as  to  the  value 
of  the  property  and  the  price  it  would  probably  bring 
at  a  public  sale.  If  it  appear  to  be  to  the  best  inter- 
ests of  those  concerned,  the  court  may  order  that  the 
property  be  sold  at  private  sale. 

The  sale  is  conducted  by  an  officer  whom  the  court 
appoints  for  that  purpose. 

All  the  parties  interested  are  entitled  to  notice  of 
the  time  and  place  of  sale.  They  should  receive  due 
notice  in  advance  so  that  they  shall  have  a  timely 
opportunity  to  protect  their  security  against  a  defi- 
ciency. The  decree  of  the  court  states  what  notice 
shall  be  given;  but  if  there  is  some  statute  .in  the 


i82  RAILROAD  BONDS  AND  NOTES 

State  where  the  property  is  sold,  which  regulates 
these  notices,  its  requirements  must  be  strictly  fol- 
lowed. The  usual  method  of  giving  notice  is  by  a 
series  of  advertisements  in  newspapers,  designated  in 
the  decree. 

The  court,  or  the  officer  whom  the  court  has  ap- 
pointed to  conduct  the  sale,  may  adjourn  or  postpone 
the  sale  on  the  application  of  the  interested  parties 
when  it  is  shown  that  it  is  for  the  best  interests  of  all 
that  it  be  done. 

Preventing,  stopping,  or  setting  aside  the  sale; 
reasons  therefor;  losing  rights  by  delay,  by 
participation;  effect  of  setting  aside  sale. 

Bondholders  have  the  right  to  have  the  sale  pre- 
vented, stopped,  or  set  aside,  when  sufficient  grounds 
exist.  The  most  common  ground  is  that  of  fraud  in 
some  form. 

That  the  price  for  which  the  property  was  sold  is 
inadequate  is  not  sufficient  reason  in  itself  for  setting 
a  sale  aside.  Nor  will  a  sale  be  vacated  because  it  is 
likely  that  the  property  would  bring  more  on  a  re- 
sale. 

To  induce  the  court  to  interfere  on  the  ground  of 
insufficiency  of  price,  it  must  be  shown  that  the  inad- 
equacy is  so  great  as  to  excite  the  suspicion  of  the 
court.  If  the  inadequacy  of  price  be  so  gross  as  to 
lead  to  the  inference  that  it  was  not  an  honest  sale, 


FORECLOSING  THE  MORTGAGE          183 

the  court  will  set  it  aside.  And,  too,  the  court  will 
interfere  when  the  inadequacy  of  price  is  accom- 
panied by  circumstances  that  suggest  fraud. 

A  combination  among  bidders  is  ground  to  set 
aside  the  sale  only  when  fraud  is  shown.  The  most 
common  instance  of  fraud  in  this  relation  is  the 
attempt  to  stifle  competition  in  bidding.  A  combi- 
nation between  bondholders  and  stockholders  for  the 
purpose  of,  and  which  will  have  the  effect  of,  depriv- 
ing the  unsecured  creditors  of  their  rights  has  been 
condemned  by  the  courts  and  the  sale  under  such  cir- 
cumstances set  aside. 

Those  entitled  to  have  the  sale  set  aside  must 
move  promptly  because  by  an  unreasonable  delay 
they  may  lose  their  rights  to  do  so.  To  excuse  delay 
in  this  regard  it  must  be  shown  that  the  facts  urged 
as  the  reason  for  setting  the  sale  aside  did  not  come 
previously  to  the  knowledge  of  the  one  seeking  this 
relief;  and  that  he  applied  to  the  court  for  relief 
against  the  objectionable  sale  within  a  reasonable 
time  after  he  acquired  such  knowledge.  But  his  lack 
of  knowledge  of  the  facts  must  not  be  the  result  of 
any  neglect  on  his  part.  He  must  show  that  by 
reasonable  diligence  he  could  not  have  discovered  the 
fraud  sooner.  But  if  the  means  of  knowledge  be 
open  to  him,  he  is  charged  with  such  knowledge  that 
with  reasonable  diligence  he  could  have  discovered. 
What  is  an  unreasonable  delay  in  one  case  may  not 


184  RAILROAD  BONDS  AND  NOTES 

be  in  another.  What  constitutes  an  unreasonable 
delay  depends  upon  the  circumstances  and  facts  of 
each  particular  case. 

A  bondholder  may  also  lose  his  rights  to  object  to 
a  sale  by  participating  in  the  transaction.  The  law 
then  assumes  that  by  his  conduct  he  has  consented  to 
the  transaction  and  thereby  loses  his  right  to  object. 

Should  the  court  set  aside  the  sale,  it  attempts  to 
put  the  parties  in  the  same  position,  so  far  as  prac- 
ticable, as  they  were  before  the  improper  sale  took 
place.  And  should  setting  aside  the  sale  interfere 
with  the  rights  of  innocent  third  parties,  who  have 
in  the  meantime  dealt  with  the  parties  or  the  prop- 
erty and  without  knowledge  of  any  wrong  have 
acquired  rights  in  the  property,  then  the  court  will 
protect  such  interests  as  the  situation  justifies. 

Terms  of  sale ;  payment  of  bid  by  bondholders. 

The  terms  of  the  sale  are  fixed  by  the  decree  of 
the  court  ordering  the  property  sold.  It  may  and  it 
usually  does  fix  a  price  below  which  the  property  may 
not  be  sold.  This  is  called  the  "upset  price."  In 
some  States  there  are  laws  to  the  effect  that  before 
the  property  of  a  railroad  shall  be  sold  at  foreclosure 
it  shall  be  appraised  to  determine  its  value  by  pub- 
lic appraisers  appointed  by  the  court  or  designated 
by  such  statute. 

The  court  may  require  that  each  bidder  shall  make 
a  deposit  of  a  specified  sum  of  money  to  insure  good 


FORECLOSING  THE  MORTGAGE          185 

faith  in  bidding.  This  is  a  precaution  against 
"straw"  bidding.  Should  the  sale  not  be  confirmed 
by  the  court,  the  deposit  is  returned. 

The  decree  may  permit  the  sale  to  be  made  on 
credit.  On  account  of  the  large  sums  involved,  rail- 
road property,  ordinarily,  is  not  salable  if  all  cash  be 
insisted  upon.  The  court  may  compel  the  purchaser 
to  pay  in  cash  a  specified  portion  of  his  bid  and  allow 
him  time  to  pay  the  balance.  When  the  property 
is  sold  on  credit,  the  court  continues  the  lien  of  the 
bondholders  under  their  mortgage  against  the  prop- 
erty in  the  hands  of  the  purchaser  for  any  unpaid 
balance  of  the  bid. 

When  the  bondholders  under  the  foreclosed  mort- 
gage are  the  purchasers,  they  are  usually  permitted 
to  pay  their  bid  with  their  bonds  and  coupons  after 
paying  in  cash  the  costs  of  the  litigation  and  such 
other  charges  as  the  court  may  direct.  The  bonds 
and  the  coupons  are  then  accepted  as  the  equivalent 
of  the  sum  to  which  they  would  be  entitled  to  receive 
upon  a  final  distribution  as  their  proportionate  shares 
of  the  proceeds  of  the  sale. 

The  property  of  a  railroad  company,  running 
through  two  or  more  States  and  situated  at  numerous 
places,  is  always,  and  most  naturally  so,  subject  to 
claims  of  many  kinds  and  of  different  legal  ranks 
and  priorities;  and  there  follows  the  inevitable  con- 
flict between  these  different  classes  of  creditors  as  to 


186  RAILROAD  BONDS  AND  NOTES 

their  respective  rights  and  priorities  with  respect  to 
certain  or  all  of  the  property  of  the  insolvent  road. 

Should  the  trustee,  with  a  railroad  in  such  a  con- 
dition, attempt  to  take  possession  and  to  operate  the 
road,  he  may  find  himself  the  center  of  a  complex 
situation,  and  subject  himself  to  many  new  responsi- 
bilities, liabilities,  and  embarrassments.  As  a  rule, 
therefore,  he  deems  it  the  wiser  and  safer  course  to 
foreclose  the  mortgage  and  thus  put  the  entire 
matter  into  court  and  ask  it  to  assume  control  and 
administer  the  property  and  affairs  of  the  railroad 
company  through  its  receiver.  He  does  this  by 
bringing  an  action  to  foreclose  the  mortgage. 

While  the  action  of  foreclosure  progresses,  the 
receiver  continues  the  road  in  operation.  Incidental 
to  his  management  and  operation  of  the  road,  the 
receiver  employs  help,  makes  necessary  repairs,  buys 
needed  material,  and  does  such  other  acts  as  are 
necessary  to  carry  out  his  receivership.  The  appoint- 
ment of  the  receiver  and  his  qualifications,  his  duties, 
powers,  and  liabilities,  and  his  relation  to  the  prop- 
erty in  his  care,  and  to  the  bondholders  and  the  other 
interested  parties,  are  discussed  in  detail  in  the  fol- 
lowing chapter. 


CHAPTER  VI 


Receivership  generally ;  outline  of  management  and 
operation  of  road  by  receiver. 

The  foreclosure  of  the  mortgage  places  the  mort- 
gaged property  under  the  control  of  the  court.  It 
is  the  duty  of  the  court  to  preserve  and  to  protect  this 
property  and  the  interests  of  all  concerned  in  it. 

The  court  preserves  the  property  and  protects  the 
interests  of  the  parties  in  it  by  taking  the  mortgaged 
road  out  of  the  hands  of  the  officers  of  the  railroad 
company  and  placing  it  in  charge  of  its  receiver. 
The  court  then  administers  the  property  through  its 
receiver.  As  the  value  of  railroad  property  consists 
chiefly  in  its  worth  as  a  working  unit  and  an  income- 
producing  and  going  concern,  the  court  usually  con- 
tinues the  road  in  operation.  The  receiver  operates 
under  the  supervision  of  the  court  and  under  the 
charter  of  the  railroad  company.  The  receiver  takes 
the  income  of  the  road  during  such  period  and  applies 
it  to  the  expenses  of  the  receivership,  making  such 
other  payments  as  the  court  may  direct.  He  also 
gathers  the  assets  of  the  railroad  company.  In  the 

course  of  his  management,  the  receiver  employs  help, 

187 


i88  RAILROAD  BONDS  AND  NOTES 

buys  needed  material  and  supplies,  makes  all  expend- 
itures necessary  to  keep  the  road  in  operation  or  to 
save  the  property  from  loss  or  depreciation.  He 
renders  a  final  accounting  at  the  conclusion  of  the 
receivership,  and  also  such  intermediate  accountings, 
from  time  to  time,  as  the  court  may  direct,  showing 
his  receipts  and  disbursements ;  and  he  distributes  the 
moneys  in  his  hands  as  the  court  orders  him.  He 
continues  in  control  until  the  court  directs  him  to 
turn  over  the  property.  This  usually  happens  when 
the  property  is  sold  at  the  foreclosure  sale  or  is  turned 
over  pursuant  to  some  plan  for  the  reorganization  of 
the  road.  It  takes  time  to  carry  out  a  reorganization 
of  a  railroad  or  to  adjust  its  affairs;  the  receiver 
therefore  may  continue  in  control  and  operation  of  a 
railroad  for  a  considerable  period,  sometimes  for  sev- 
eral years,  while  a  reorganization  is  being  worked 
out  or  an  adjustment  perfected. 

Grounds  for  receivership ;  when  appointed ;  default 
in  interest  or  principal ;  insolvency ;  inadequate 
security ;  when  income  mortgaged ;  threatened 
waste  of  property ;  application  by  railroad  com- 
pany. 

The  appointment  of  a  receiver  is  never  a  matter 
of  absolute  right.  It  is  for  the  court  to  decide 
whether  or  not  one  is  necessary.  And  before  the 
appointment  is  made  it  must  be  shown  to  the  satis- 
faction of  the  court  that  a  receivership  is  necessary 


RECEIVERSHIP  OF  RAILROAD  COMPANY      189 

to  prevent  loss  or  injury  to  those  financially  inter- 
ested. 

Application  for  the  receivership  is  made  usually 
by  the  trustee  of  the  mortgage,  and  on  the  ground 
that  the  railroad  company  has  defaulted  in  the  pay- 
ment of  the  interest  or  the  principal  of  the  bonds,  or 
has  defaulted  under  the  mortgage  in  some  other  par- 
ticular, that  it  is  insolvent,  and  that  the  security  is 
inadequate.  Generally,  the  fact  alone  that  the  com- 
pany has  defaulted  in  principal  or  interest  of  the 
bonds  is  not  sufficient  grounds  for  the  appointment 
of  a  receiver,  though  it  gives  the  right  to  foreclose 
the  mortgage  or  otherwise  realize  on  the  security. 
Nor  is  the  insolvency  of  the  railroad  company  alone 
sufficient  ground  for  a  receivership,  unless  made  so 
by  the  statutory  law  of  the  state,  or  unless  such  in- 
solvency is  caused  by  fraud  or  such  mismanagement 
by  the  officials  of  the  company  that  it  is  necessary  to 
interfere  to  save  the  assets  and  protect  the  rights  of 
those  financially  concerned.  A  judgment  creditor  is 
sometimes  entitled  to  the  appointment  of  a  receiver. 

However,  such  default  or  insolvency  in  connection 
with  other  circumstances,  such  as,  that  the  mortgaged 
property  is  an  inadequate  security,  or  that  the  officers 
of  the  railroad  company  are  wasting  this  property, 
misapplying  the  income  of  the  road  or  otherwise  con- 
ducting themselves  in  a  manner  prejudicial  to  the  in- 
terests of  the  bondholders,  will  generally  influence 
the  court  to  appoint  a  receiver. 


igo  RAILROAD  BONDS  AND  NOTES 

When  it  is  the  duty  of  the  trustee  under  the  mort- 
gage to  take  possession  of  the  road,  upon  a  default  of 
the  company,  and  he  fails  to  do  so  or  improperly 
does  so,  the  court  will  appoint  a  receiver  for  that  pur- 
pose. 

Upon  the  foreclosure  of  a  mortgage  covering  the 
income  and  profits  of  the  railroad  company,  the  court 
usually  appoints  a  receiver  to  take  these  moneys  to 
prevent  their  misapplication. 

As  a  rule,  the  receiver  is  appointed  as  one  of  the 
steps  in  the  foreclosure  action;  but  there  are  cases 
when  the  court  may  appoint  a  receiver  before  the 
railroad  company  has  actually  defaulted  under  its 
mortgage  and  the  trustee  or  the  bondholders  have 
the  right  to  sue  on  such  default.  Such  a  case  is  when 
the  railroad  is  insolvent  and  unable  to  meet  its  obli- 
gations soon  to  fall  due  and  there  is  danger  that  the 
property  covered  by  the  mortgage  may  be  wasted  or 
impaired  by  its  management.  Under  such  circum- 
stances, when  the  default  is  imminent,  the  court,  in 
order  to  prevent  this  probable  loss,  will  take  the  man- 
agement of  the  road  from  those  who  caused  this  con- 
dition and  will  place  it  in  the  hands  of  a  receiver  who 
will  better  serve  the  public  and  the  persons  financially 
interested. 

The  railroad  company  itself  may,  in  extreme  cases, 
apply  for  a  receivership,  as,  when  it  is  insolvent  and 
its  property  is  likely  to  be  wasted  or  lost  if  it  con- 
tinues in  operation.  Dissension,  however,  in  the 


RECEIVERSHIP  OF  RAILROAD  COMPANY      191 

management  of  a  railroad  company,  as  a  rule,  does 
not  justify  the  appointment  of  a  receiver. 

Attitude  of  the  courts  towards  receiverships  of  rail- 
roads; serving  the  interests  of  the  public  and 
the  bondholders. 

It  is  with  extreme  caution,  if  not  with  reluctance, 
that  courts  undertake  to  appoint  a  receiver  of  a  rail- 
road, as  the  effect  of  the  appointment  is  to  suspend 
the  operation  of  the  road  by  the  corporation  to  which 
the  franchise  to  do  so  was  given  and  place  it  in  the 
hands  of  a  receiver,  and  in  most  cases  devolving  upon 
the  court,  to  a  greater  or  less  degree,  the  management 
of  the  business  of  the  railroad  company.  Therefore, 
the  need  of  a  receivership  must  be  shown  clearly  be- 
fore the  court  will  make  the  appointment.  It  must 
be  shown  that  loss  or  injury  to  the  property  involved 
will  result  if  a  receiver  be  not  appointed. 

The  court  will  not  take  lightly  the  management 
of  a  railroad  from  the  officers  of  the  company  and 
place  it  in  the  hands  of  a  receiver.  And  when  it 
does  so  it  is  to  preserve  the  property  until  the  financial 
embarrassment  of  the  company  has  passed,  or  the 
property  is  disposed  of  for  the  best  interests  of  those 
concerned,  under  the  circumstances.  It  seeks  to  save 
the  security  to  the  bondholders  by  taking  it  in  its 
care.  Public  policy  demands  that  a  railroad  needed 
as  a  means  for  transportation  of  persons  and  property 
shall  not  be  permitted  to  rust  in  disuse  and  its  fran- 


192  RAILROAD  BONDS  AND  NOTES 

chise  forfeited ;  the  court,  therefore,  seeks  to  serve  the 
public  by  continuing  the  road  in  operation.  And, 
from  the  standpoint  of  the  bondholders,  better  results 
are  obtained  if  the  road  is  continued  in  operation  and 
sold  as  a  going  and  an  income-producing  business, 
notwithstanding  that  expenses  may  be  incurred  which 
are  paid  out  of  the  mortgaged  property  in  full  before 
the  bondholders  receive  anything. 

Appointment  is  discretionary  with  the  court;  con- 
sent of  parties  interested ;  bond  of  receiver. 

Whether  or  not  a  receiver  shall  be  appointed  is  a 
matter  resting  in  the  sound  discretion  of  the  court. 
This  discretion,  however,  is  exercised  according  to 
precedents  which  depend,  in  their  application,  upon 
the  facts  and  circumstances  that  each  case  presents. 
Nevertheless,  in  every  case,  before  the  court  will 
appoint  a  receiver,  there  must  be  presented  to  it  facts 
from  which  the  necessity  for  the  receivership  must 
appear.  Those  facts  and  conditions  which  the  prece- 
dents have  regarded  as  sufficient  reasons  for  a  receiv- 
ership have  been  previously  discussed.  See  Grounds 
for  receivership,  etc.  Page  188. 

The  fact  that  the  interested  parties  consent  to  a 
receivership  is  not  decisive  or  binding  on  the  court. 
The  court  is  not  bound  by  their  consent.  It  may 
ignore  their  consent  and  refuse  to  make  an  appoint- 
ment. 

As  a  general  rule,  the  court  will  require  the  re- 


RECEIVERSHIP  OF  RAILROAD  COMPANY      193 

ceiver  before  he  will  be  permitted  to  take  possession 
of  the  property,  to  execute  and  file  a  bond,  with  sure- 
ties, in  an  amount  fixed  by  the  court,  for  the  faith- 
ful performance  of  his  duties  as  receiver,  that  he  will 
carry  out  all  orders  of  the  court  and  that  he  will 
render  his  accounting.  The  sureties  on  the  bond 
bind  themselves  to  the  effect  that  the  receiver  will 
perform  his  duties  faithfully,  that  he  will  carry  out 
all  orders  of  the  court,  that  he  will  render  account- 
ings of  the  property  he  has  received  and  of  his  re- 
ceipts and  disbursements  and  of  all  his  official  acts, 
whenever  required  to  do  so,  and  that  should  he  fail 
in  any  of  these  particulars,  then  to  those  who  suffer 
a  loss  as  a  result  of  his  wrongful  acts  or  failure  to 
act,  they  will  pay  such  damages  as  may  be  sustained. 
The  liability  of  the  sureties  in  the  aggregate  shall  not 
exceed  the  amount  mentioned  in  the  bond.  The 
bond  and  the  financial  standing  of  the  sureties  are 
passed  upon  by  the  court  should  there  be  any  ques- 
tion raised  about  them. 

Effect  of  receivership  on  existing  rights ;  on  mort- 
gages or  other  liens ;  attaching  creditors ;  judg- 
ment creditors;  suits  against  the  receiver. 

The  appointment  of  a  receiver  does  not  change  the 
rights  of  any  of  the  parties  in  their  relation  to  the 
mortgaged  property.  It  merely  stops,  for  the  time 
being,  the  enforcement  of  these  rights  and  remedies 
by  other  legal  actions  or  proceedings.  All  persons 


194  RAILROAD  BONDS  AND  NOTES 

having  claims  against  the  mortgaged  property  or 
against  the  insolvent  road  must  prove  their  claims  in 
the  action  or  proceeding  then  before  the  court  in 
which  the  receiver  has  been  appointed,  and  their 
interests  are  determined  there  with  the  same  effect 
as  if  each  had  brought  a  separate  action  for  that 
purpose. 

The  property  comes  into  the  possession  of  the  re- 
ceiver subject  to  all  the  mortgages  and  other  liens 
that  exist  against  it  at  that  time.  The  receivership 
does  not  affect,  in  any  way,  the  legal  standing  of 
such  mortgages,  other  liens,  or  claims,  nor  their  re- 
spective rights  to  priorities  in  payment,  except  that 
the  court  may  direct  that  "operating  expenses"  be 
paid  out  of  the  moneys  in  the  hands  of  the  receiver 
in  preference  to  other  claims;  or,  it  may  order  the 
receiver  to  issue  receiver's  certificates  to  raise  money 
to  preserve  the  property,  and  may  order  that  they  be 
a  first  lien  on  that  property  and  paid  before  all 
mortgages,  certain  other  liens  and  claims.  See 
Operating  expenses  prior  to  receivership,  etc.  Page 
245.  See  Receiver's  certificates.  Page2lo. 

The  receivership  adds  nothing  to  the  rights  of  the 
parties  who  procured  the  appointment.  It  does  not 
dissolve  the  railroad  corporation.  It  merely  means 
that  the  court  has  taken  charge  through  its  officer. 
And  when  the  court  has  the  property  thus  in  its  pos- 
session, those  creditors  who  have  secured  attachments 
against  the  company  may  not  enforce  them  against 


RECEIVERSHIP  OF  RAILROAD  COMPANY      195 

the  property  in  the  hands  of  the  receiver;  nor  may 
those  creditors  who  have  sued  the  railroad  company 
and  obtained  judgment  then  enforce  their  judgments 
against  this  property.  To  do  so  is  a  contempt  of 
court  and  is  punishable  by  fine  or  imprisonment,  or 
both.  The  property  being  in  the  possession  of  the 
receiver,  no  creditor  shall  take  it  or  interfere  with  it 
without  the  court's  permission.  Their  claims  must 
be  adjudicated  in  the  suit  before  the  court  in  which 
the  receiver  has  been  appointed,  because  in  that  suit 
the  court  determines  the  rights  of  all  parties  inter- 
ested, in  any  way,  in  that  property. 

After  a  receiver  has  been  appointed,  no  suit  may  be 
brought  against  him  in  his  official  capacity  without 
permission  of  the  court.  To  do  so  is  a  contempt  of 
the  court,  for  the  receiver  is  the  officer  of  the  court 
and  shall  not  be  interfered  with  in  his  possession  of 
the  property  or  the  performance  of  any  of  his  duties 
without  permission  of  the  court. 

Ancillary  receiverships ;  road  running  through  two 
or  more  states;  appointment  of  same  receiver 
in  each  jurisdiction;  jurisdiction  of  courts  of 
each  state;  may  appoint  their  own  receiver. 

Courts  have  no  power  to  appoint  a  receiver  to  act 
outside  of  the  State  or  the  territory  over  which  they 
have  jurisdiction.  The  jurisdiction  of  the  courts  of 
each  State  is  limited  to  the  territory  embraced  within 
that  State.  The  jurisdiction  of  a  Federal  court  cov- 


196  RAILROAD  BONDS  AND  NOTES 

ers  only  the  territory  within  its  own  district,  which  in 
some  districts  extends  over  several  States.  The  re- 
ceiver has  no  power  to  act  in  places  over  which  the 
court  that  appointed  him  has  no  jurisdiction. 

Where  a  road  runs  through  several  States  and 
beyond  the  jurisdiction  of  the  court  that  first  ap- 
pointed the  receiver,  the  management  of  the  entire 
road  is  usually  placed  in  the  charge  of  the  receiver 
first  appointed,  by  the  courts  of  the  other  States 
appointing  him  as  their  receiver  to  act  within  their 
respective  jurisdictions.  These  second  appoint- 
ments, by  these  other  courts,  are  called  ancillary 
receiverships.  Should  each  court  appoint  a  different 
receiver,  confusion  is  inevitable.  Such  ancillary 
receiverships  are  made,  therefore,  to  bring  about  har- 
mony of  management  and  the  satisfaction  that  results 
therefrom. 

However,  the  court  making  the  ancillary  appoint- 
ment does  not  surrender  its  powers  to  make  such 
orders  with  regard  to  that  portion  of  the  road  within 
its  own  jurisdiction,  as  it  may  deem  necessary  for  the 
best  interests  of  all  the  parties  in  the  different  pro- 
ceedings. The  court  of  ancillary  appointment 
while,  as  a  rule,  it  directs  the  receiver  to  follow  the 
orders  of  the  court  of  initial  or  original  appointment, 
may  disregard  them  and  may  direct  the  conduct  of 
the  receiver  within  its  own  jurisdiction,  according  to 
its  own  orders. 

Should  the  courts  of  the  different  States  or  juris- 


RECEIVERSHIP  OF  RAILROAD  COMPANY      197 

dictions  through  which  the  road  runs  refuse  to 
appoint  the  same  person  as  receiver  within  their  re- 
spective jurisdictions,  then  each  may  appoint  its  own 
receiver  to  act  within  its  jurisdiction,  under  its  direc- 
tion, and  with  or  without  regard  to  the  orders  of  the 
other  courts. 

But  it  is  universally  recognized  that  conflict  and 
confusion  must  follow  where  concurrent  receiverships 
control  a  railroad;  therefore,  notwithstanding  the 
fact  that  each  has  the  power  to  act  independently  of 
the  others,  the  courts  of  this  country,  through  the 
comity  between  them,  as  a  rule,  make  ancillary 
appointments  of  receivers,  and  each  directs  the  re- 
ceiver within  its  jurisdiction  to  carry  out  the  orders 
of  the  court  that  first  acquired  control  of  the  road 
and  made  the  original  or  initial  appointment.  How- 
ever, each  court  will  do  so  only  when  such  orders 
are  not  against  the  public  policy  of  its  own  State  or 
do  not  conflict  with  or  violate  any  of  its  own  laws. 
They  will  try  to  follow  the  course  of  the  court  of 
initial  appointment,  so  far  as  they  consistently  can, 
so  that  they  may  grant  to  their  own  citizens  remedies 
and  rights  equal  to  those  enjoyed  by  the  citizens  of 
that  other  State. 

Receivership  of  parent  company  and  of  branch  or 
subsidiary  lines. 

When  a  receiver  has  been  appointed  for  the  parent 
or  controlling  company  of  a  system  of  railroads,  the 


198  RAILROAD  BONDS  AND  NOTES 

bondholders  secured  by  mortgages  on  the  branch,  con- 
trolled, allied,  or  subsidiary  lines  or  roads  may  have 
their  own  receiver  for  each  mortgage  to  represent 
their  respective  interests  in  each  of  such  roads  or 
lines. 

Who  is  chosen  as  receiver;  consent  of  parties;  his 
qualifications. 

The  courts  select  as  their  receivers  those  who  are 
acceptable,  so  far  as  can  be,  to  all  parties.  Some 
railroad  mortgages  provide  that  the  holders  of  a  cer- 
tain proportion  of  the  outstanding  bonds  under  that 
mortgage  shall  have  the  right  to  nominate  a  receiver. 
The  person  that  the  bondholders  thus  nominate,  or 
that  the  parties  to  the  litigation  may  have  agreed 
upon,  and  urge  upon  the  court  for  appointment,  need 
not  necessarily  be  its  choice.  However,  the  court  is 
generally  influenced  by  the  consent  of  the  interested 
parties;  though  it  may  ignore  their  suggestion  and 
appoint  whom  it  believes  will  best  serve  the  interests 
of  all  concerned.  The  interests  of  creditors  of  all 
grades  and  of  all  persons  who  may  be  affected  by  the 
receivership  are  considered  in  the  appointment. 

The  court  usually  selects  as  its  receiver  a  person 
of  recognized  ability  and  standing,  in  whose  hands 
all  can  feel  assured  that  their  interests  will  be  hon- 
estly and  ably  taken  care  of.  He  should  be  disin- 
terested. The  court  will  not  appoint  any  one  whose 


RECEIVERSHIP  OF  RAILROAD  COMPANY      199 

interests  are  opposed  to  those  of  the  bondholders  or 
others  interested  in  the  property. 

An  officer  of  the  railroad  may  be  appointed  re- 
ceiver. If  the  insolvency  which  caused  the  receiver- 
ship resulted  from  mismanagement  of  the  affairs  of 
the  railroad  company,  the  court  will  not  appoint  any 
one  connected  with  that  management.  As  skill  and 
experience  in  the  management  of  railroads  together 
with  a  knowledge  of  the  affairs  of  the  road  in  ques- 
tion are  desirable,  the  court  may  appoint  an  officer  of 
the  railroad  company  when  its  insolvency  was  not 
due  to  any  fault  on  his  part. 

Receiver  represents  the  court;  subject  only  to  its 
control. 

The  receiver  represents  no  class  of  creditors;  not 
even  that  class  of  creditors  at  whose  instance  he  was 
appointed.  His  possession  of  the  property  in  his 
care  is  that  of  the  court  that  appointed  him.  The 
court  holds  the  property  with  the  hands  of  its  receiver 
as  its  officer,  and  he  is  responsible  to  it  for  all  his 
official  acts.  The  receiver  is  the  arm  of  the  court 
doing  its  bidding.  He  is  in  no  way  subject  to  the 
direction  of  the  railroad  company,  the  trustee,  the 
bondholders  or  any  other  creditors. 

The  receiver  must  carry  out  the  orders  of  the 
court  as  they  are  issued,  from  time  to  time,  and  his 
failure  to  do  so  may  render  him  personally  liable  in 


200  RAILROAD  BONDS  AND  NOTES 

money  damages  and  also  for  contempt  of  court. 
His  sureties  become  liable  for  any  money  loss  suffered 
because  the  receiver  does  not  carry  out  the  orders  of 
the  court. 

General  powers  and  duties  of  receiver  while  operat- 
ing the  road;  application  to  the  court  for  in- 
structions and  authority;  what  the  court  gen- 
erally allows  the  receiver  to  do. 

Immediately  upon  his  appointment  the  receiver 
takes  possession  of  the  property  covered  by  the  mort- 
gage, and  gathers  all  these  assets.  He  should  then 
proceed  upon  such  a  course  as  will  save  to  the  bond- 
holders, the  other  creditors,  and  all  other  persons  in- 
terested financially,  the  largest  amount  in  the  short- 
est time.  He  should  study  carefully  the  problem, 
not  only  how  to  conserve  the  security  of  the  bond- 
holders, but  also  how  to  serve  the  interests  of  the 
public. 

His  appointment  gives  him  the  right  to  the  imme- 
diate possession  of  the  property  over  which  he  is  ap- 
pointed. The  court  protects  the  receiver  in  his 
possession  and  control  of  the  property  it  has  placed 
in  his  charge,  and  any  unjustifiable  interference  with 
him  in  the  discharge  of  his  duties  and  the  possession 
of  the  property  is  a  contempt  of  court,  punishable  by 
fine  or  imprisonment,  or  both. 

In  continuing  the  business  of  the  railroad  com- 
pany, the  receiver  has  substantially  the  same  powers 


RECEIVERSHIP  OF  RAILROAD  COMPANY      201 

as  the  railroad  company  has  and  is  subject  substan- 
tially to  the  same  liabilities  as  it  is.  He  has  the 
right  to  use  the  charter  under  which  the  company 
operated. 

When  the  receiver  is  in  doubt  as  to  his  rights  or 
powers  he  should  apply  to  the  court  that  appointed 
him  for  advice  and  instruction. 

If  necessary  for  the  profitable  operation  of  the 
road,  the  court  may  authorize  its  receiver  to  complete 
an  unfinished  branch  line  or  other  work.  When  ad- 
visable and  likely  to  be  productive  of  good  results, 
the  court  may  authorize  the  receiver  to  make  traffic 
contracts  with  other  companies  or  carry  out  those 
already  made  by  the  railroad  company;  also  to  lease 
property  to  others  or  to  lease  property  from  others, 
when  necessary  for  the  advantageous  operation  and 
management  of  the  road.  The  court  will  also  au- 
thorize him,  under  proper  conditions,  to  borrow 
money  to  purchase  rolling  stock  and  materials  and  to 
pay  for  labor  necessary  for  the  operation  of  the  road. 

The  court  may  permit  the  receiver  to  settle  or  to 
compromise  claims  against  the  railroad  company. 
Generally,  the  receiver  should  pay  no  claims  against 
the  railroad  company  unless  permitted  by  the  court. 

The  court  will  ratify  or  subsequently  approve  any 
act  done  by  the  receiver  without  authority  if  it  be 
such  as  it  would  have  permitted  if  previously  ap- 
plied to.  Those  contracts,  expenses,  or  other  acts 
which  the  court  usually  authorizes  in  the  first  in- 


202  RAILROAD  BONDS  AND  NOTES 

stance,  or  subsequently  ratifies  or  approves,  are,  gen- 
erally, those  necessary  to  preserve  the  property  and 
maintain  the  road  in  operation. 

Discretion  of  the  receiver  in  the  management  and 
operation  of  the  road. 

Should  the  receiver  be  compelled  to  obtain  permis- 
sion from  the  court  for  every  act  incidental  to  the 
management  and  operation  of  a  great  business  like  a 
railroad  it  would  seriously  interfere  with,  if  not  pre- 
vent, the  carrying  out  of  the  very  objects  of  the 
receivership.  It  would  necessitate  the  court  passing 
upon  every  detail  of  the  business  and  would  take  up 
its  entire  time  to  the  exclusion  of  other  litigation. 

Therefore,  while  the  receiver  is  always  under  the 
control  of  the  court,  yet  in  the  operation  and  manage- 
ment of  the  road,  he  is  authorized  by  law  to  act 
according  to  his  best  judgment  with  respect  to  those 
ordinary  and  necessary  matters  arising  incidentally. 
He  is  permitted  a  reasonable  discretion.  Under  this 
discretion  which  the  law  gives  him  he  may  make  re- 
pairs to  keep  the  road  in  proper  condition;  he  may 
dismiss  any  of  the  employees  of  the  company  and 
engage  others  in  their  places.  He  may  engage  legal 
counsel  when  necessary.  As  to  such  matters  and 
those  others  that  arise  incidentally  in  the  manage- 
ment and  operation  of  the  road  he  need  not  ask  per- 
mission of  the  court,  but  may  act  according  to  his 
own  discretion. 


RECEIVERSHIP  OF  RAILROAD  COMPANY     203 

Effect  of  the  contracts  of  the  insolvent  road  on  the 
receiver;  leased  lines;  leases  of  rolling  stock; 
car  trust  agreements. 

The  contracts  which  the  railroad  company  made 
while  in  possession  and  operation  of  the  road  con- 
front the  receiver  upon  taking  charge.  Such  con- 
tracts may  be  a  lien  on  the  property  the  receiver  takes 
over;  they  are  then  binding  on  him  to  the  extent  of 
such  lien.  Where  such  contracts  are  not  liens 
against  the  property  the  receiver  is  not  bound  by 
them  unless  he  accepts  and  adopts  them.  That  is, 
he  may  reject  those  he  believes  unprofitable  or  unde- 
sirable, and  may  accept  those  he  believes  beneficial. 
He  must  make  his  decision  within  a  reasonable  time 
after  his  appointment.  His  discretion,  however,  is 
neither  arbitrary  nor  absolute  nor  uncontrolled. 
His  action  in  this  particular  is  subject  to  review  by 
the  court.  He  must  act  in  good  faith. 

The  court  will  not  permit  him  to  accept  and  carry 
out  those  contracts  that  are  prejudicial  or  which 
may  diminish  the  assets  or  otherwise  prove  harmful. 
Should  the  receiver  adopt  or  show  an  intention  to 
adopt  objectionable  contracts,  the  interested  parties 
who  may  be  harmed  thereby  may  apply  to  the  court 
for  relief.  The  official  acts  of  the  receiver  are 
always  subject  to  the  control  of  the  court. 

When  the  receiver  takes  over  a  railroad,  he  usually 
finds  that  the  road  is  operating  one  or  more  lines  by 
means  of  a  lease,  and  using  rolling  stock  under  a  lease 


204  RAILROAD  BONDS  AND  NOTES 

or  a  "car  trust"  agreement.  Rolling  stock  comprises 
the  cars  and  locomotives  used  in  conveying  persons 
and  property,  that  is,  employed  in  the  business  of 
a  railroad  company. 

Whether  or  not  the  receiver  shall  continue  to  op- 
erate the  leased  line  under  the  lease  and  adopt  it  is, 
under  the  rule  stated,  for  him  to  decide.  He  has  a 
reasonable  time  within  which  to  make  his  decision. 
In  the  meantime  he  may  continue  to  operate  such 
leased  line  and  his  so  doing  will  not  be  construed  as 
an  acceptance  and  adoption  of  that  lease  by  him. 
However,  while  operating  the  road  under  the  lease 
during  this  tentative  period,  he  must  pay  for  its  use. 
If  the  lease  is  adopted  then  the  receiver  pays  the 
amount  agreed  upon  in  such  lease.  Where  the  lease 
is  ultimately  rejected,  then  the  court  will  fix  the 
amount  of  compensation  to  be  paid  to  the  lessor  of 
the  leased  road  for  the  time  the  receiver  used  it. 
The  amount  that  the  court  fixes  is  not  necessarily  at 
the  rate  mentioned  in  the  lease,  but  is  the  fair  and 
reasonable  value  for  that  period,  depending  upon  the 
circumstances  under  which  he  took  and  operated  such 
leased  road.  The  amount  ordered  to  be  paid  may 
be  at  the  rate  mentioned  in  the  lease  if  that  be  the 
fair  and  reasonable  value. 

The  same  rule  applies  to  the  rolling  stock  used  by 
the  railroad  company  under  a  lease.  Should  the 
receiver  adopt  the  lease  of  the  rolling  stock  or  the 
court  order  him  to  do  so,  the  rental  mentioned  in  the 


RECEIVERSHIP  OF  RAILROAD  COMPANY     205 

lease  under  which  it  was  used  must  be  paid.  The 
receiver  or  the  court  may  refuse  to  adopt  the  lease, 
whereupon  the  property  is  turned  over  to  its  owners; 
however,  should  the  receiver  have  need  for  this  roll- 
ing stock,  notwithstanding  his  rejection  of  the  lease, 
he  may  continue  using  it.  And  for  the  time  that  he 
uses  it,  he  must  pay  what  its  use  is  fairly  and  rea- 
sonably worth  during  that  period.  This  fair  and 
reasonable  value  may  be  at  the  rate  fixed  in  the  lease, 
though  not  necessarily  so.  The  amount  that  the  re- 
ceiver pays  is  what  the  court  fixes. 

The  rolling  stock  may  be  used  by  the  railroad  com- 
pany under  a  "car  trust"  agreement.  Under  such  an 
agreement,  the  railroad  company  uses  rolling  stock 
belonging  to  an  association,  paying  rent  periodically 
for  its  use  for  a  specified  time  (usually  ten  years), 
and  on  the  understanding  that  at  the  end  of  that  term 
the  aggregate  of  all  the  rentals  shall  constitute  the 
purchase  price,  and  that  thereupon  the  railroad  com- 
pany shall  become  the  owner  of  the  rolling  stock. 
The  court  may  order  the  receiver  to  continue  the 
payment  of  rentals  and  thus  complete  the  purchase, 
which  is  usually  done  when  the  greater  part  of  the 
sum  has  already  been  paid.  See  Car  Trust  Certifi- 
cates or  Bonds.  Page  316. 

Should  the  court  deem  it  advisable  not  to  continue 
this  "car  trust"  agreement — which  is  usually  done 
when  only  a  small  part  of  the  purchase  price  has 
been  paid — it  may  order  the  property  turned  over 


206  RAILROAD  BONDS  AND  NOTES 

to  its  owners.  However,  the  court  may  refuse  to 
adopt  the  "car  trust"  agreement  and  yet  direct  the 
receiver  to  continue  using  such  rolling  stock;  the 
receiver  then  pays  to  its  owner  what  its  use  is  fairly 
and  reasonably  worth  for  the  period  he  uses  it. 
What  shall  be  the  fair  and  reasonable  value  is  deter- 
mined by  the  court. 

Such  use  of  the  property  of  another  after  refusing 
to  be  bound  by  the  agreement  under  which  it  was 
originally  taken  may  seem  an  arbitrary  disposal  of 
its  owner's  rights  in  his  property,  but  it  is  justified 
on  the  ground  that  it  is  railroad  property  that  the 
court  has  taken  in  its  care,  property  charged  with  the 
obligation  to  continue  as  a  public  highway,  in  which 
those  persons  having  private  property  rights  are  not 
alone  interested,  but  in  which  the  public  is  vitally 
concerned.  And  there  are  times,  such  as  these,  when 
public  interests  demand  that  private  interests  in 
property  give  way  to  them.  Persons  dealing  with 
railroads  or  railroad  property  are  charged  with  a 
knowledge  of  how  the  law  regards  property  and  cor- 
porations of  this  character  and  must  have  in  mind 
what  may  follow. 

Expenditures  by  the  receiver. 

The  details  of  the  management  and  operation  of 
the  road  are  left,  to  some  extent,  as  was  seen,  to  the 
discretion  of  the  receiver.  So,  too,  he  is  allowed  a 
certain  discretion  as  to  expenditures  in  the  course  of 


RECEIVERSHIP  OF  RAILROAD  COMPANY     207 

his  receivership.  This  exercise  of  discretion  must  be 
characterized  always  by  good  faith. 

The  receiver  is  permitted  by  law,  without  first 
obtaining  permission  of  the  court,  to  expend  such 
moneys  and  incur  such  obligations  for  expenses  as 
are  necessary  to  preserve  the  property  and  operate 
the  road  in  its  ordinary  management,  provided  they 
are  not  for  a  large  amount  or  for  an  unusual  pur- 
pose. 

When  unusual  matters  arise  or  large  expenditures 
are  called  for  the  receiver  must  apply  to  the  court  for 
permission  to  act. 

The  necessity,  the  nature,  and  the  amount  of  the 
expenditure  determines  its  propriety. 

Expenditures  for  large  amounts  or  for  unusual  pur- 
poses; making  unusual  contracts. 

Before  acting  in  a  matter  involving  a  large  amount 
the  receiver  should  first  get  authority  from  the  court 
to  do  so.  The  same  rule  applies  to  expenditures  for 
unusual  purposes.  Nor  should  he  make  any  contract 
that  is  unusual  or  which  by  its  terms  will  extend 
beyond  the  probable  period  of  his  receivership,  with- 
out permission  from  the  court.  Should  the  receiver 
make  expenditures  for  a  large  amount,  or  for  an  un- 
usual purpose,  or  enter  into  a  contract  that  is  un- 
usual, without  first  obtaining  permission  from  the 
court,  he  takes  the  risk  of  what  the  court  will  sub- 
sequently do  in  the  matter.  The  court  may  approve 


208  RAILROAD  BONDS  AND  NOTES 

his  acts,  or  it  may  only  partly  approve  them,  or  it 
may  refuse  entirely  to  sanction  the  expenditure  or 
the  contract  in  question.  Should  the  court  with- 
hold its  approval,  the  receiver,  having  acted  beyond 
the  scope  of  his  authority,  will  be  held  personally 
liable  and  the  property  in  his  care  as  receiver  will 
not  be  bound  by  or  charged  with  such  contracts  or 
expenditures.  However,  where  the  property  has 
been  actually  benefited  by  such  expenditure,  the 
court  may  permit  such  sums  as  benefited  the  prop- 
erty to  be  allowed  and  to  be  paid  as  an  expense  of 
the  receivership. 

With  respect  to  expenditures  for  large  amounts, 
or  for  unusual  purposes,  or  the  making  of  unusual 
contracts,  the  court  will  not  authorize  them  in  the 
first  instance,  nor  subsequently  approve  them,  unless 
they  are  necessary  to  preserve  the  property  and  main- 
tain the  road  in  operation. 

Ordinarily,  the  court  will  not  permit  the  receiver 
to  expend  money  to  complete  unfinished  work.  The 
objection  is  that  it  is  entering  upon  a  new  enterprise 
and  casts  upon  the  property  in  the  hands  of  the  re- 
ceiver an  additional  burden.  But  when  absolutely 
necessary  to  preserve  the  property  and  prevent 
deterioration  or  loss,  the  court  may,  under  some  cir- 
cumstances, permit  the  receiver  to  complete  unfin- 
ished work.  On  this  proposition  no  fixed  rule  can 
be  laid  down ;  the  action  of  the  court  on  the  question 
of  finishing  uncompleted  work  depends  upon  the 


RECEIVERSHIP  OF  RAILROAD  COMPANY      209 

particular  facts  and  circumstances  of  each  case  be- 
fore it. 

Income  during  receivership;  how  applied;  antici- 
pating income. 

The  income  taken  in  by  the  receiver  is  used  first 
to  pay  the  expenses  of  the  receivership.  Expenses 
of  the  receivership  include  the  cost  of  maintaining 
and  operating  the  road,  wages  of  help,  claims  for 
repairs  and  materials  furnished  in  the  course  of  op- 
eration, and  the  rentals  of  leased  lines  and  leased 
rolling  stock. 

Should  there  be  insufficient  income  to  pay  the 
expenses  of  the  receivership,  they  may  be  charged 
against  the  property  itself. 

Should  there  be  sufficient  income  left  after  the 
expenses  of  the  receivership  are  paid,  to  pay  the  in- 
terest that  was  defaulted  on  the  bonds  whose  mort- 
gage is  being  foreclosed,  or  the  interest  accruing 
thereon  and  falling  due  during  the  foreclosure  action, 
the  court  may  order  it  paid;  if  not,  or  if  the  court 
cannot  safely  make  such  an  order,  it  will  not  do  so. 
And  sometimes  even  though  there  be  enough  to  pay 
the  interest  mentioned,  it  will  be  withheld  by  the 
receiver  to  meet  operating  expenses  shortly  to  fall 
due  or  to  be  incurred;  or  it  may  be  withheld  to  pay 
claims  that,  by  law,  are  given  a  preference,  and 
which  the  court  may  order  paid  first. 

Judgments  and  claims  for  injuries  to  persons  or 


210  RAILROAD  BONDS  AND  NOTES 

property  caused  by  the  receiver  or  his  employees  in 
the  course  of  the  operation  of  the  road  are  also  paid 
out  of  the  income  earned  by  the  receiver  as  an  ex- 
pense of  the  receivership. 

Should  the  income  of  the  road  be  insufficient  to 
meet  current  expenses,  or  to  make  repairs  or  improve- 
ments necessary  to  preserve  the  property,  the  court 
may  anticipate  future  income  by  ordering  the  re- 
ceiver to  borrow  money  and  may  secure  such  indebt- 
edness by  making  it  a  first  lien  upon  the  property  in 
the  possession  of  the  receiver. 

The  receiver  borrows  money,  under  these  circum- 
stances, by  issuing  and  selling  receiver's  certificates. 

Receiver's  certificates ;  only  when  absolutely  neces- 
sary; unusual  security;  lien  the  court  gives 
them;  several  issues;  when  payable;  rate  of 
interest;  selling  price;  obligations  of  receiver; 
their  form  and  transfer;  enforcing  their  pay- 
ment; reasons  for  displacing  bondholder's 
lien;  notice  to  bondholders;  entitled  to  be 
heard. 

The  receiver  ordinarily  pays  the  expenses  of  oper- 
ating and  maintaining  the  road  during  his  receiver- 
ship out  of  the  earnings  of  that  period.  However, 
when  current  income  is  insufficient  to  pay  current 
expenses,  or  should  money  be  needed  to  preserve  the 
property  by  making  improvements  or  otherwise  keep- 
ing the  road  in  a  proper  condition  of  efficiency,  the 


RECEIVERSHIP  OF  RAILROAD  COMPANY      211 

court  may  order  the  receiver  to  borrow  money  to  meet 
these  requirements.  The  receiver  then  under  the 
direction  of  the  court  issues  receiver's  certificates, 
which  are  sold  to  raise  the  necessary  money.  Good 
results  must  be  likely  from  the  use  of  the  money  thus 
raised;  and  if  such  money  is  not  absolutely  necessary, 
the  court  will  not  order  the  certificates  to  be  issued. 

It  must  be  apparent  that  investors  are  not  likely 
to  lend  money  to  be  secured  by  property  a  mortgage 
upon  which  is  already  under  foreclosure,  and  a  re- 
ceiver appointed  on  the  ground  that  the  security  is 
probably  insufficient  to  meet  the  demands  already 
against  it.  An  extraordinary  security  must  be  of- 
fered. Therefore,  for  the  payment  of  the  receiver's 
certificates  the  court  pledges  its  faith  and  the  prop- 
erty in  its  custody,  and  gives  these  certificates  such 
lien  against  this  property,  or  priority  in  payment  out 
of  its  proceeds,  as  the  situation  justifies. 

The  court  usually  makes  the  receiver's  certificates 
a  first  lien  upon  the  franchise,  income,  and  prop- 
erty of  the  road  that  is  in  its  care,  and  orders  that  the 
certificates  shall  be  superior  to  all  other  liens,  except 
of  course,  those  for  public  taxes.  While  the  certifi- 
cates are  usually  made  a  first  lien,  the  court  may 
order  that  they  be  a  first  and  prior  lien  only  as  to 
some  of  the  liens  against  the  property  and  a  junior, 
subsequent,  or  inferior  lien  as  to  others.  The  or- 
der of  the  court  authorizing  the  certificates  states 
just  what  legal  position  or  lien  they  shall  have  with 


212  RAILROAD  BONDS  AND  NOTES 

relation  to  other  liens  and  to  the  property  against 
which  they  are  charged. 

When  some  bondholders  ask  that  receiver's  certifi- 
cates be  issued,  and  others  do  not  join  in  that  appli- 
cation, or  they  are  issued  against  the  protests  of  the 
latter,  the  court  may  place  the  burden  upon  those  who 
originally  asked  for  them.  That  is,  it  may  direct 
that  the  certificates  be  a  lien  upon  only  such  propor- 
tion of  the  property,  or  its  proceeds,  as  the  holdings 
of  those  bondholders  who  asked  for  the  certificates, 
bear  to  the  entire  bonds  outstanding  and  secured  by 
that  property;  and  that  the  certificates  shall  not  af- 
fect the  rights,  or  the  interests,  or  the  lien  on  the 
property,  -of  those  bondholders  who  have  opposed 
the  issue.  But,  as  was  seen,  the  court  may,  notwith- 
standing the  objection  of  the  dissenting  bondholders, 
displace  their  lien  and  give  the  receiver's  certificates 
a  prior  lien. 

Where  there  are  several  issues  of  certificates  their 
respective  ranks  are  fixed  by  the  court. 

When  the  certificates  are  made  a  first  lien  they  are 
paid  out  of  the  proceeds  of  the  property  they  are 
charged  against  before  any  other  claims,  except 
those  of  a  public  nature,  as  taxes,  are  paid  there- 
from; or  the  property  may  be  sold  subject  to  the  lien 
of  the  certificates,  when  payment  may  be  enforced 
out  of  the  property  in  the  hands  of  the  purchaser; 
or  they  may  be  made  a  condition  of  reorganization 
of  the  road,  whereby  the  new  corporation  shall  be- 


RECEIVERSHIP  OF  RAILROAD  COMPANY      213 

come  liable  for  their  payment  and  satisfy  them  in 
money  or  in  securities  of  the  new  corporation. 

Should  the  proceeds  of  the  property  be  insufficient 
to  pay  all  the  certificates  of  that  issue  in  full,  the 
holders  share  proportionately. 

Receiver's  certificates  are  made  payable  either  at 
a  fixed  time  or  when  the  property  shall  be  sold  or 
disposed  of  by  the  court.  The  order  of  the  court 
authorizing  the  certificates  states  when  they  shall  be 
payable, — at  a  fixed  time  or  upon  the  sale  or  other 
disposition  of  the  property. 

The  rate  of  interest  the  certificates  shall  bear  and 
the  price  at  which  the  receiver  may  sell  them  is  also 
fixed  by  the  court.  Should  the  court  make  no  order 
permitting  the  receiver  to  sell  at  less  than  par,  then 
he  may  not  do  so.  Should  the  receiver  sell  at  less 
than  par,  without  permission  of  the  court,  the  pur- 
chaser is  entitled  to  demand  and  receive  only  what 
he  actually  paid.  But  if  the  court  authorized 
their  sale  by  the  receiver  at  less  than  par,  a  purchaser 
at  the  authorized  price  is  entitled  to  demand  and  re- 
ceive their  face  amount. 

Receiver's  certificates  are  the  obligations  of  the 
receiver  and  not  of  the  railroad  company.  •  They 
may  be  made  negotiable  in  form,  that  is,  payable  to 
bearer  or  to  the  order  of  a  named  payee  and  assigned 
by  him  in  blank.  They  are  not,  however,  ne- 
gotiable instruments  in  the  strict  legal  sense  of  the 
term,  such  as  promissory  notes  or  bonds  may  be. 


214  RAILROAD  BONDS  AND  NOTES 

When  the  certificates  are  payable  to  bearer  they  are 
transferable  by  mere  delivery  from  hand  to  hand 
without  any  writing  or  any  formality  other  than 
their  manual  delivery.  When  payable  to  order  they 
are  transferred  by  written  assignment  and  delivery. 

As  a  general  rule,  the  holder  of  the  certificate  is 
not  entitled  to  sue  for  its  payment  by  a  separate 
action.  His  remedy  usually  is  to  apply  for  relief  to 
the  court  that  has  the  foreclosure  proceedings  in 
charge,  and  which  ordered  the  certificates  to  be  is- 
sued. But  where  the  property  is  sold  subject  to  the 
lien  of  the  certificates,  the  purchaser  thereby  taking 
the  property  over  subject  to  their  payment,  an  in- 
dependent action  will  then  lie  against  such  property 
in  the  hands  of  its  purchaser. 

It  is  an  extraordinary  power  that  the  court  as- 
sumes to  exercise  in  displacing  the  lien  and  the 
priority  of  the  bondholder's  mortgage  in  favor  of  the 
certificates  of  the  receiver.  This  power  is  exercised 
only  in  the  cases  of  railroad  and  other  quasi-public 
corporations.  Corporations  of  this  nature,  though 
composed  of  private  individuals  united  for  private 
gain,  are  engaged  in  enterprises  that  serve  the  public 
and  are  immediately  connected  with  the  public  wel- 
fare. The  franchises  or  special  privileges  necessary 
to  carry  on  the  enterprises  in  which  they  are  engaged 
are  obtained  from  the  people  of  the  State.  The 
people,  therefore,  who  have  given  these  valuable 
franchises  are  vitally  interested  in  seeing  that  such 


RECEIVERSHIP  OF  RAILROAD  COMPANY      215 

enterprises  (as  the  exclusive  means  of  transporta- 
tion of  passengers  and  freight  between  certain  ter- 
mini) shall  continue  in  operation  and  that  these 
special  privileges  or  franchises  shall  not  be  neg- 
lected. Should  a  railroad  suddenly  cease  operation, 
it  would  interfere  with  business  and  social  life,  ar- 
rest progress  and  development,  and  be  a  serious  pub- 
lic loss,  the  extent  of  its  harmful  effect  depending 
upon  the  size  and  location  of  the  road.  The  rail- 
road company  when  it  accepts  its  franchise  from  the 
people  assumes  the  duty  to  maintain  and  operate  the 
road  and  serve  the  public  from  whom  it  has  accepted 
this  special  privilege.  And  it  is  this  duty  and  that 
it  shall  be  performed,  that  the  court  has  in  mind,  to 
a  great  extent,  when  it  appoints  a  receiver  to  con- 
tinue the  road  in  operation  and  permits  him  to  bor- 
row money  to  do  so.  And  all  persons  are  charged 
with  a  knowledge  of  this  duty  to  continue  maintain- 
ing and  operating  the  road;  and  all  persons  are 
charged  also  with  the  knowledge  that  when  neces- 
sary to  carry  out  this  duty,  the  receiver  may  be  per- 
mitted to  borrow  money,  and  to  secure  same  may 
issue  certificates  which  may  be  made  a  first  lien  on 
the  property  of  the  railroad  corporation,  displacing 
the  liens  of  mortgages  to  secure  bonds. 

And  from  the  standpoint  of  the  bondholders  it 
may  be  urged  that  rapid  diminution  of  the  value  of 
the  property  covered  by  their  mortgage  would  follow 
if  it  were  not  for  the  timely  aid  of  the  money  raised 


216  RAILROAD  BONDS  AND  NOTES 

by  the  certificates.  The  true  value  of  railroad  prop- 
erty lies  in  its  worth  as  a  going  concern  and  in  its 
income  earning  capabilities.  And  while  it  may  seem 
a  hardship  on  the  bondholders  to  have  their  lien  dis- 
placed by  the  certificates,  it  must  be  remembered  that 
the  money  raised  by  them  comes  at  a  time  when  it 
can  be  used  most  advantageously  to  give  life  to  the 
security  and  to  continue  it  in  existence,  or  to  make  it 
more  efficient,  and  thus  produce  better  results  than 
would  have  been  probable  without  it. 

Nevertheless,  the  courts  approach  the  subject  of 
receiver's  certificates  with  great  caution  as  the  cer- 
tificates may  defeat  the  very  purpose  for  which  they 
were  employed.  For,  while  they  are  intended  to 
preserve  and  improve  the  mortgaged  property  and 
enhance  its  value  by  keeping  it  going  as  an  income- 
producing  business  so  that  the  bondholders  who  have 
had  their  lien  displaced  may  realize  more  than  they 
would  have  done  if  their  property  had  been  left  in  its 
original  condition,  it  has  happened  that  such  results 
have  not  followed  and  that  bondholders  have  been 
"improved"  out  of  the  equity  they  originally  had  in 
the  property.  It,  therefore,  must  be  shown  to  the 
satisfaction  of  the  court  that  the  saleable  value  of 
the  property  will  be  increased  as  a  result  of  the  use  of 
the  money  to  be  obtained  by  the  certificates,  before 
it  will  order  that  they  be  issued.  The  court  will 
refuse  to  order  certificates  if  it  believes  the  result 
doubtful. 


RECEIVERSHIP  OF  RAILROAD  COMPANY      217 

The  condition  of  the  property  may  be  such  that 
the  court  may  consider  it  more  advisable  to  stop  run- 
ning the  road  and  hasten  matters  to  a  foreclosure 
sale. 

Accordingly,  receiver's  certificates  are  issued  only 
when  absolutely  necessary  and  when  good  results  are 
likely.  And  the  purpose  for  which  they  are  issued 
is  limited  to  raise  money  to  preserve,  to  repair,  and 
to  equip  the  road  and  to  maintain  it  as  a  going  con- 
cern. Courts  will  not,  as  a  rule,  order  certificates 
to  be  issued  to  complete  unfinished  work  beyond 
what  is  necessary  for  the  preservation  of  the  property 
in  its  care. 

Before  the  court  permits  the  receiver  to  issue  cer- 
tificates, the  bondholders  must  receive  notice  of  the 
application  and  must  have  an  opportunity  to  be 
heard.  They  are  entitled  to  their  day  in  court. 
Bondholders  are  protected  in  the  security  that  the 
lien  of  their  mortgage  gives  them  and  this  priority 
will  not  be  taken  from  them  without  their  consent. 
However,  to  depend  upon  an  actual  consent  would 
often  defeat  the  issuance  of  the  certificates.  The  un- 
warranted and  unfounded  objection  of  some  of  the 
bondholders  is  not  permitted  to  interfere  with  nor 
to  thwart  an  act  intended  for  the  good  of  the  greater 
number  and  the  public,  and  in  which  the  court  seeks 
to  safeguard  the  interests  of  each  individual  as  well. 

At  the  hearing  the  bondholders  are  entitled  to 
show  that  the  certificates  are  not  necessary  and, 


218  RAILROAD  BONDS  AND  NOTES 

among  other  objections,  to  urge  that  they  will  do 
more  harm  than  good  to  the  security,  that  the  amount 
for  which  it  is  intended  to  issue  them  is  excessive, 
that  they  should  not  be  given  a  rank  superior  to  the 
lien  of  the  mortgage  being  foreclosed. 

When  the  affairs  of  the  railroad  company  have 
reached  a  receivership,  the  bondholders  usually  place 
their  interests  in  the  hands  of  a  committee.  Such  a 
committee  is  then  the  representative  of  the  bondhold- 
ers to  the  extent  that  they  are  bound  by  whatever  it 
does  in  their  behalf  while  acting  within  the  scope  of 
its  authority.  This  committee  usually  has  the  power 
to  consent,  if  in  its  judgment  it  be  advisable,  to  the 
issuance  of  receiver's  certificates.  Such  committee 
does  not  represent  those  bondholders  who  have  not 
consented  to  it  acting  for  them.  Those  bondholders 
who  are  not  parties  to  the  agreement  which  ap- 
pointed the  committee  are  not  bound  by  the  acts  or 
consents  of  this  committee. 

The  order  which  the  court  makes  authorizing  the 
certificates  and  fixing  their  lien  is  such  as,  under  the 
circumstances,  it  believes  will  best  serve  the  interests 
of  all  the  parties. 

If  the  certificates  are  issued  beyond  the  amount 
authorized,  the  excessive  part  of  the  issue  is  void; 
but  if  the  money  received  from  the  sale  of  such  ex- 
cessive part  has  been  used  to  benefit  the  property, 
the  court  will  aid  their  holders  to  get  their  money. 
Records  of  the  court  are  accessible  to  all  persons  who 


RECEIVERSHIP  OF  RAILROAD  COMPANY     219 

may  satisfy  themselves  whether  or  not  the  certificates 
have  been  regularly  issued. 

Official  liability  of  the  receiver;  his  personal  lia- 
bility. 

In  operating  the  road,  the  receiver,  through  his 
representatives,  may  cause  injury  to  persons  or  prop- 
erty; or  he  may  employ  help,  or  purchase  materials, 
equipment  or  other  property.  When  he  is  acting 
thus,  he  is  acting  in  an  official  capacity;  he  then  is 
officially  liable  only.  That  is,  to  pay  such  damages 
caused  persons  or  property,  or  to  pay  such  wages  for 
help,  or  to  pay  the  purchase  price  of  such  material 
or  other  property,  only  the  property  in  his  possession 
as  receiver  (official  property),  can  be  reached.  He 
is  not  personally  liable  in  such  matters,  and  neither 
is  he  nor  are  his  sureties  liable  on  the  receiver's  bond. 
These  are  receivership  liabilities,  incurred  while  act- 
ing as  an  officer  of  the  court,  and  they  must  be  paid 
only  out  of  receivership  property. 

The  receiver,  however,  is  personally  liable  if  he 
personally  caused  the  injuries  or  the  damages  just 
mentioned ;  or  if  he  failed  to  exercise  reasonable  care 
in  the  selection  of  the  employees  who  did.  He  is 
also  personally  liable  if  he  pledged  his  individual 
credit  in  the  hiring  of  help  or  the  purchase  of  any 
property. 

The  railroad  company  is  not  liable  for  the  acts  of 
the  receiver  where  he  is  in  entire  possession  and  con- 


220  RAILROAD  BONDS  AND  NOTES 

trol.  The  railroad,  therefore,  is  not  liable  for  in- 
juries to  persons  or  damages  to  property  while  the 
road  is  operated  exclusively  by  the  receiver. 
Should  the  receiver  and  the  railroad  company  jointly 
operate  the  road  the  latter  continues  liable. 

Liability  of  sureties  on  receiver's  bond. 

The  receiver  may  be  required  by  the  court  to  turn 
over  certain  property,  or  to  make  certain  payments, 
or  to  do  other  acts  specified  in  its  order.  Should  he 
fail  to  obey  the  orders  of  the  court  in  any  of  these 
particulars,  then  those  who  are  entitled  to  receive 
such  property  or  such  payments,  or  to  the  benefits 
of  such  other  acts,  may  recover  from  the  receiver, 
personally,  damages  for  any  loss  they  may  suffer  by 
reason  of  his  failure  to  obey  the  orders  of  the  court 
in  such  respect.  These  orders  are  directed  against 
the  receiver  personally.  If  it  be  shown  that  the 
receiver  cannot  pay  such  damages,  then  the  sureties 
on  the  receiver's  bond  are  liable;  and  upon  obtaining 
permission  of  the  court  they  may  be  sued  on  their 
bond. 

Accounting  by  the  receiver. 

The  receiver  must  render  an  accounting  to  the 
court  that  appointed  him.  Each  person  interested 
in  the  receivership  is  entitled  to  know,  from  time  to 
time,  what  the  receiver  is  doing. 

He  must  keep  his  accounts  and  vouchers  for  pay- 


RECEIVERSHIP  OF  RAILROAD  COMPANY     221 

ments  made  by  him  so  that  all  persons  interested 
may  examine  them  at  reasonable  times. 

At  the  conclusion  of  the  receivership,  the  receiver 
renders  his  final  accounting;  and  he  must  also  ac- 
count at  such  other  times,  and  as  often  as  the  court 
directs  him  to.  A  failure  to  comply  with  the  order 
of  the  court  in  this  respect  is  cause  for  his  removal. 

The  accounting  of  the  receiver  is  filed  with  the 
court  for  its  approval.  Any  person  interested  as  a 
party  or  claimant  may  object  to  any  or  all  of  the 
items  of  the  accounting.  A  hearing  is  had  before 
the  court  on  these  disputed  items.  Sometimes  the 
court  itself  passes  on  these  items  in  dispute;  usually 
the  accounting  is  sent  by  the  court  to  a  referee  or 
master  to  examine  into  all  items,  disputed  and  other- 
wise. The  referee  or  master  reports  his  findings  to 
the  court  for  final  approval  or  disapproval.  In 
passing  upon  the  accounting  the  court  specifies  the 
sums  it  allows  for  compensation  to  the  receiver,  to 
legal  counsel,  and  for  other  services. 

The  books  of  the  railroad  company  in  the  pos- 
session of  the  receiver  should  be  open  at  all  reason- 
able times  to  the  inspection  of  the  parties  interested. 

Removal  of  the  receiver ;  his  resignation. 

The  court  that  appointed  the  receiver  may  remove 
him  from  office.  Any  attempt  on  his  part  to  ad- 
vance his  own  personal  interests  at  the  expense  of 
the  property  or  funds  in  his  care  is  cause  for  his 


222  RAILROAD  BONDS  AND  NOTES 

removal.  So,  too,  is  his  collusion  or  any  other  im- 
propriety in  procuring  his  appointment.  The  in- 
competency  of  the  receiver  is  ground  for  his  removal. 
A  mere  error  in  judgment,  where  there  is  no  bad 
faith,  will  be  pardoned.  But  should  errors  of  judg- 
ment show  a  lack  of  capacity,  the  court  will  remove 
the  receiver.  Failure  of  the  receiver  to  render  an 
accounting  when  ordered  to  do  so  by  the  court  is 
sufficient  cause  for  his  removal. 

Generally,  the  receiver  will  be  removed  for  any 
misconduct  that  subjects  the  property  to  danger. 

Should  there  be  more  than  one  receiver,  a  lack  of 
harmony  among  them  that  menaces  the  rights  of  the 
bondholders  and  the  others  concerned  in  the  receiver- 
ship is  good  ground  for  the  removal  of  all.  The 
court  then  usually  appoints  one  receiver  in  their 
stead.  Other  situations  may  arise  when  the  court 
may  deem  it  advisable  that  the  receivership  be  placed 
in  different  hands  for  management. 

As  has  been  said  so  many  times,  the  receiver  is  the 
officer  of  the  court  and  bound  to  do  its  bidding,  and 
when  he  has  undertaken  his  duties  he  may  not  avoid 
them  arbitrarily  by  resigning.  He  must  obtain  per- 
mission of  the  court  to  resign.  The  courts  usually 
give  the  receiver  permission  to  resign,  under  proper 
circumstances,  and  then  appoint  another  in  his  place. 

The  removal  of  the  receiver  does  not  in  any  way 
affect  the  receivership.  The  rights  of  all  remain  the 
same.  The  only  change  that  takes  place  is  that  the 


RECEIVERSHIP  OF  RAILROAD  COMPANY     223 

court  now  acts  through  a  new  receiver  in  place  of  the 
deposed  one. 

Compensation  of  the  receiver;  fixed  by  statute  or 
the  court ;  forfeiting  compensation ;  paid  out  of 
property  or  by  contribution. 

The  receiver  is  allowed  compensation  for  the 
services  rendered  by  him  in  the  proper  discharge  of 
his  duties. 

In  some  of  the  states  the  rate  of  compensation  is 
fixed  by  statute.  He  is  then  paid  according  to  that 
rate. 

When  there  are  no  statutes  fixing  the  rate  of  com- 
pensation, it  is  determined  by  the  court.  In  doing 
so,  the  court  considers  the  amount  of  work  the 
receiver  actually  and  necessarily  did,  the  manner  in 
which  he  performed  his  duties,  the  fidelity  and  busi- 
ness capacity  he  brought  to  bear,  the  amount  in- 
volved, and  the  responsibilities  he  assumed.  The 
court  bases  its  determination  upon  the  particular  facts 
of  each  case.  The  court  allows  a  lump  sum.  The 
percentage  basis  of  compensation  is  not  used  by  the 
court.  And  in  arriving  at  that  sum  the  salaries  paid 
to  public  officers  for  similar  services  are  sometimes 
used  as  a  standard.  The  salary  of  the  president  of 
the  road  has  in  some  cases  been  considered  a  measure 
of  compensation.  In  some  instances  this  would  be 
insufficient  and  in  others  excessive.  As  has  been 
said,  each  case  depends  upon  its  own  particular  facts. 


224  RAILROAD  BONDS  AND  NOTES 

Where  the  misconduct  of  the  receiver  has  been 
such  that  the  court  believes  he  is  not  entitled  to  any 
compensation,  having  forfeited  it  by  his  misbehavior, 
it  may  refuse  him  any  compensation  whatever. 

The  receiver  is  compensated  out  of  the  property 
in  his  charge.  Should  that  property  fail  or  be  in- 
sufficient to  adequately  compensate  the  receiver,  then 
the  bondholders  and  those  others  at  whose  instance 
he  was  appointed  must  provide,  by  assessment  or  con- 
tribution, the  money  necessary  for  his  payment.  But 
where  the  receivership  was  procured  by  the  bond- 
holders under  a  second  mortgage,  the  prior  mortgage 
bondholders  are  not  assessed  or  otherwise  held  to  con- 
tribute unless  they  took  an  active  part  in  the  liti- 
gation. 

Termination  of  the  receivership. 

The  receivership  serves  but  a  temporary  purpose : 
it  comes  to  an  end  when  its  objects  have  been  accom- 
plished. Then,  there  being  no  further  necessity  for 
its  existence,  the  court  will  discharge  the  receiver, 
and  relieve  him  from  further  liability.  The  receiver 
is  usually  discharged  after  the  foreclosure  sale  or 
when  the  reorganization  of  the  road  has  been  carried 
out.  There  is  then  no  longer  any  property  to  take 
care  of  and  there  is  no  longer  need  for  his  services. 
The  receiver  now  renders  his  final  accounting  and  is 
discharged  by  the  court,  unless  it  believes  it  is  neces- 
sary to  continue  him  in  office  for  a  while  to  close  up 


RECEIVERSHIP  OF  RAILROAD  COMPANY     225 

other  matters  that  may  have  arisen.  When  the  re- 
ceiver shall  be  discharged  and  the  receivership  termi- 
nated rests  in  the  sound  discretion  of  the  court.  The 
receivership  must  not  be  prolonged  unnecessarily;  but 
it  will  be  continued  so  long  as  the  court  believes  there 
is  need  for  it. 

The  moneys  the  receiver  takes  in  during  his  opera- 
tion of  the  road,  and  the  proceeds  of  the  sale  of  the 
property  under  foreclosure  or  otherwise,  are  dis- 
tributed under  the  direction  of  the  court.  Usually 
there  are  many  claims  of  different  kinds.  Some  are 
entitled  to  be  paid  out  of  certain  property,  or  its  pro- 
ceeds, to  the  exclusion  of  all  others.  Sometimes  sev- 
eral classes  of  creditors  are  entitled  to  share  propor- 
tionately in  a  fund;  sometimes  they  share  according 
to  their  respective  priorities  or  preferences,  as  to 
which  there  may  be  a  conflict.  These  priorities  or 
preferences  in  payment  depend  in  some  instances 
upon  the  fact  that  the  mortgage  or  other  lien  which 
gives  them  such  priority  or  preference  attached  to 
the  property  in  question  before  the  lien  of  the  others ; 
or  because  of  the  nature  of  the  claims ;  or  because  by 
order  of  the  court  they  have  been  made  a  charge 
against  certain  property;  or  because  some  bondhold- 
ers, having  a  certain  priority,  consent  to  waive  it  in 
favor  of  others  who  have  advanced  money  to  the 
road  at  a  later  and  critical  time;  or  because  of  such 
other  reasons  as  the  complex  conditions  that  the  in- 
solvency of  the  road  presents. 


226  RAILROAD  BONDS  AND  NOTES 

These  priorities  and  preferences  in  payment  out  of 
the  property  and  funds  before  the  court,  and  the 
reasons  for  each,  and  the  general  rules  applied  in  the 
distribution  of  the  assets  of  the  insolvent  railroad 
company,  are  discussed  in  the  following  chapter. 


CHAPTER  VII 

RIGHTS  AND  REMEDIES  WITH  RELATION  TO  THE 
ASSETS  OF  THE  INSOLVENT  RAILROAD  COM- 
PANY; RIGHTS  AND  PRIORITIES  OF  THE  OTHER 
CREDITORS 

General  rules  of  distribution  of  assets  of  the  insol- 
vent road ;  mortgages  and  other  liens ;  secured 
and  unsecured  creditors. 

As  a  general  statement  it  may  be  said  that  such 
property  of  the  insolvent  road  upon  which  there  are 
mortgages  or  other  liens  is  reserved  to  the  payment 
of  the  claims  secured  by  these  mortgages  or  other 
liens;  and  such  claims  so  secured  are  paid  in  full, 
according  to  their  respective  priorities,  out  of  that 
property  before  any  other  creditors  receive  anything 
from  it. 

When  a  mortgage  is  foreclosed  and  property  is 
thus  before  the  court,  it  orders  it  sold  and  the  pro- 
ceeds of  the  sale  are  distributed  under  its  direction 
to  those  whom  it  finds  to  be  entitled  thereto. 

When  the  property  is  sold  under  foreclosure,  the 
costs  and  expenses  of  the  foreclosure  action  and  of 

the  sale  are  paid  first.     Then  those  claims  are  paid 

227 


228  RAILROAD  BONDS  AND  NOTES 

that  the  statutes  of  the  State  give  preferences  to,  and 
those  which  the  court  orders  to  be  preferred.  After 
claims  of  these  classes  are  paid  in  full,  the  balance 
of  the  proceeds  of  the  property  is  applied  to  the  pay- 
ment of  those  who  have  mortgages  or  other  liens 
against  the  property  sold.  These  claims  secured  by 
such  mortgages  or  other  liens  are  paid  according  to 
their  respective  legal  ranks  and  priorities.  After  all 
these  claims  are  paid  in  full  the  balance,  if  any,  is 
paid  to  the  general  or  unsecured  creditors.  Should 
there  be  anything  left  after  all  these  payments  are 
made  in  full,  it  is  turned  over  to  the  railroad  com- 
pany. 

In  addition  to  those  creditors  who  have  secured 
themselves  by  mortgages  or  other  liens,  and  those  to 
whom  the  statutes  of  the  different  States  give  a 
preference  and  priority,  there  are  claims,  such  as  re- 
ceiver's certificates  and  operating  expenses,  to  which 
the  court  may  give  a  certain  preference  out  of  income 
or  property  itself,  depending  upon  the  circumstances 
of  each  case,  and  which  it  orders  paid  sometimes 
before  the  bondholders  and  the  coupon  holders  under 
the  defaulted  mortgage. 

Each  class  of  creditors  is  paid  in  full  before  those 
of  the  succeeding  class  receive  anything. 

Should  there  not  be  enough  to  pay  all  the  cred- 
itors of  a  class  in  full,  they  share  proportionately. 
For  any  unpaid  balance  they  become  general  or 
unsecured  creditors;  they  then  share  proportionately 


PRIORITIES  OF  THE  OTHER  CREDITORS      229 

with  the  other  unsecured  creditors  in  whatever  fund 
that  may  be  left  for  such  unsecured  creditors. 

The  funds  to  which  the  general  or  unsecured  cred- 
itors have  recourse  are  those  produced  by  the  pro- 
ceeds of  all  property  upon  which  there  are  no  mort- 
gages or  other  liens ;  and  in  addition  all  that  remains 
of  property  upon  which  there  are  mortgages  or 
other  liens,  after  such  mortgages  and  other  liens  have 
been  satisfied  in  full. 

Claims  not  yet  due  are  also  paid,  but  with  a  reduc- 
tion of  interest  for  the  unexpired  period. 

Income  earned  by  the  railroad  company  before  de- 
fault ;  after  default ;  income  earned  by  receiver. 

We  have  just  seen  generally  how  the  property  of 
the  insolvent  road,  when  sold  under  foreclosure,  is 
distributed.  To  the  distribution  of  certain  income 
that  the  road  earns,  rules  are  applied  that  should 
receive  separate  consideration. 

The  railroad  company  is  entitled  to  the  income  it 
earns,  as  against  the  bondholders,  while  it  is  in  pos- 
session and  operates  the  road.  This  is  so  even  when 
the  income  is  mortgaged  and  specifically  included 
in  the  mortgage.  Mortgaged  income  means  net 
income.  Net  income  is  what  is  left  of  current  in- 
come after  payment  of  expenses  necessary  to  produce 
it.  See  Operating  expenses  prior  to  receivership. 
Page  245.  For  it  is  the  duty  of  the  railroad  com- 
pany while  in  operation  to  apply  its  current  income 


230  RAILROAD  BONDS  AND  NOTES 

to  the  payment  of  its  current  expenses.  Its  current 
income,  therefore,  after  the  payment  of  the  current 
expenses  necessary  to  produce  it,  thus  making  it  net 
income,  belongs  to  the  railroad  company  until  it 
defaults  under  the  mortgage  and  the  receiver  under 
order  of  the  court  or  the  trustee  under  the  mortgage, 
as  the  case  may  be,  demands  possession  of  the  mort- 
gaged property.  Thereupon  it  belongs  to  such  re- 
ceiver or  trustee. 

Even  when  mortgaged,  the  trustee  or  the  receiver, 
as  the  case  may  be,  is  entitled  only  to  the  income 
earned  after  the  company  defaults  under  the  mort- 
gage and  such  trustee  or  the  receiver  has  demanded 
possession. 

Should  the  railroad  company  turn  over  any  income 
to  the  receiver  then  these  moneys,  together  with  such 
income  as  he  may  earn  himself,  are  applied  generally 
first  to  the  expenses  of  the  receivership.  Such  ex- 
penses include  all  costs  of  the  foreclosure  action, 
reasonable  compensation  for  the  receiver  and  his 
legal  counsel,  and  the  other  necessary  expenditures 
to  properly  maintain  and  operate  the  road. 

Accordingly,  claims  of  employees  for  wages, 
claims  for  materials  furnished  and  for  work  done 
during  the  receivership  are  paid  as  its  expenses. 

Those  claims  for  labor  and  materials  furnished  to 
the  railroad  company  during  the  period  of  about  six 
months  prior  to  the  receivership  which  were  neces- 
sary to  maintain  and  preserve  the  mortgaged  prop- 


PRIORITIES  OF  THE  OTHER  CREDITORS      231 

erty,  and  which  come  under  the  classification  of 
"operating  expenses,"  are  also  paid  out  of  the  income 
thus  in  the  hands  of  the  receiver.  See  Operating 
expenses  prior  to  receivership.  Page  245. 

Claims  or  judgments  for  damages  for  injuries  to 
persons  or  property  caused  while  the  road  was  oper- 
ated by  the  receiver  are  also  regarded  as  expenses 
of  the  receivership;  but  claims  or  judgments  of  this 
kind  caused  by  the  negligence  of  the  railroad  com- 
pany while  it  operated  the  road  are  regarded  quite 
generally  as  unsecured  claims  against  the  road,  and 
are  not  paid  by  the  receiver  out  of  his  income,  except 
in  those  few  States  where  statutes  give  judgments  of 
this  nature  a  preference.  See  Claims  and  judgments 
for  injuries  to  persons  or  'property.  Page  260. 

When  the  income  in  the  hands  of  the  receiver  has 
paid  all  the  expenses  of  the  receivership  and  such 
other  claims  as  may  be  specifically  charged  against 
it,  then  the  balance,  if  any,  goes  to  the  holders  of  the 
bonds  under  the  foreclosed  mortgage  and  the  other 
creditors  according  to  their  respective  rights. 

Distribution  of  income  and  proceeds  of  mortgaged 
property  when  trustee  takes  possession,  op- 
erates, or  sells. 

The  trustee  may  take  possession  of  the  mortgaged 
property  upon  default  of  the  railroad  company,  when 
such  power  is  granted  him  in  the  mortgage. 
Coupled  with  this  power  to  take  possession,  he  is  also 


232  RAILROAD  BONDS  AND  NOTES 

usually  authorized  to  operate  the  road.  See  Posses- 
sion and  operation  of  the  mortgaged  road  by  the 
trustee,  etc.  Page  154. 

The  income  that  the  trustee  earns  while  operating 
the  road,  and  such  income  as  he  may  have  received 
from  the  railroad  company,  together  with  the  pro- 
ceeds of  the  mortgaged  property,  by  sale,  lease,  or  in 
the  case  of  stocks  and  bonds,  as  dividends  or  interest, 
are  distributed  by  him  in  the  manner  that  the  mort- 
gage points  out. 

The  trustee  has  no  authority  to  take  possession  of 
the  road  or  to  operate  it  or  to  sell  it  unless  the  mort- 
gage gives  him  that  power;  and  this  same  mortgage 
that  authorizes  him  to  do  so  also  regulates  how  the 
moneys  received  or  realized  as  a  result  of  the  exercise 
of  such  power  shall  be  distributed. 

The  moneys  received  by  the  trustee,  from  all 
sources  under  the  mortgage,  are  usually  ordered  dis- 
tributed by  the  mortgage  so  that  they  shall  be  applied 
first  to  the  payment  of  the  expenses  of  the  sale  and 
of  the  trusteeship,  which  shall  include  all  necessary 
expenditures,  covering  also  his  own  compensation 
and  that  of  his  legal  counsel;  then  to  those  claims 
that  the  statutes  or  the  courts  give  preference  to; 
after  these,  to  the  payment  of  mortgages  or  other 
liens  having  priority  over  his  mortgage.  When  the 
property  is  sold  free  and  clear  of  such  prior  mort- 
gages or  other  liens,  the  full  purchase  price  is  actu- 
ally paid  and  such  prior  mortgages  or  other  liens  are 


PRIORITIES  OF  THE  OTHER  CREDITORS     233 

then  first  paid  in  full  out  of,  or  their  lien  transferred 
to,  the  purchase  price  so  paid. 

When  the  property  is  sold  subject  to  such  prior 
mortgages  and  other  liens,  their  amounts  are  taken 
into  consideration  when  the  actual  amount  of  the 
purchase  price  is  to  be  paid,  and  the  actual  cash  or 
other  payment  is  reduced  accordingly.  Then  the 
purchaser  must  satisfy  these  prior  mortgages  or  other 
liens  himself,  only,  however,  to  the  extent  that  the 
property  purchased  will  do  so.  His  liability  is  not 
a  personal  one;  the  property  rather  than  the  pur- 
chaser is  liable.  Should  that  property  be  insufficient 
to  meet  such  demands  in  full,  then  the  purchaser  is 
not  liable  for  such  deficiency,  but  for  such  unpaid 
balance  these  mortgagees  and  lienors  are  creditors  of 
the  railroad  company.  Sometimes,  however,  usually 
in  reorganization  proceedings,  the  purchaser  may 
assume  the  payment  of  the  claims  secured  by  such 
mortgages  and  other  liens  subject  to  which  the  prop- 
erty was  purchased;  then  such  purchaser,  having  as- 
sumed these  debts  secured  by  such  mortgages  or  other 
liens,  is  personally  liable  notwithstanding  that  the 
property  is  insufficient  to  pay  them. 

Should  the  property  be  sold  free  from  all  prior 
liens  and  mortgages,  and  the  trustee  has  paid  all  such 
claims,  so  secured,  in  full,  then  he  applies  the  bal- 
ance to  the  satisfaction  of  the  bonds  and  coupons  or 
claims  for  interest  under  his  mortgage.  He  usually 
pays  such  principal  and  interest,  with  interest  on 


234  RAILROAD  BONDS  AND  NOTES 

overdue  interest,  without  preference  to  either  prin- 
cipal or  interest.  Should  there  be  insufficient  to  pay 
principal  and  interest  in  full,  then  they  share  pro- 
portionately, on  an  equal  basis.  The  order  of  dis- 
tribution just  given  is  that  most  common,  though 
some  mortgages  may  make  other  arrangements  as  to 
payment  of  principal  and  interest,  or  the  priorities 
between  them;  but  the  mortgage  cannot  disturb  or 
affect  the  rights  or  priorities  to  which  others  who  are 
not  parties  to  such  an  arrangement  are  entitled. 
See  Priorities,  if  any,  between  principal  and  interest. 
Page  92.  See  also  Priorities  among  interest  cou- 
pons and  claims  for  interest.  Page  260. 

Creditors  of  the  railroad  generally;  what  is  meant 
by  priority. 

The  average  railroad  company  consists  of  a  num- 
ber of  branch  lines  operated  as  a  system. 

Upon  insolvency  it  will  be  found  that  its  property 
is  encumbered  by  a  number  of  mortgages  and  other 
liens  of  different  kinds  and  legal  ranks;  there  will  be 
claims  that  are  given  a  preference  in  payment  out  of 
the  assets  of  the  road,  either  by  law  or  by  order  of 
the  court;  and  there  will  be  found  those  creditors  who 
have  no  security  or  preference. 

To  ascertain  the  rights  of  whomsoever  may  claim 
any  interest  in  the  property  of  the  railroad  company, 
or  against  the  road,  and  determine  their  relative  pri- 
orities, is  the  task  that  confronts  the  court  at  this  time. 


PRIORITIES  OF  THE  OTHER  CREDITORS     235 

Among  the  creditors  having  mortgages  or  other 
liens  there  may  be  found  the  holders  of  bonds  se- 
cured by  the  underlying  liens  placed  by  constituent 
companies  on  the  branch  lines  they  owned  before 
consolidation;  also  first,  second,  general  or  blanket 
mortgages  on  the  entire  system.  Collateral  trust 
bonds  may  have  been  issued  by  the  parent  company, 
to  secure  which  are  pledged  stocks  and  bonds  from 
its  own  treasury  or  the  stocks  and  bonds  of  its  sub- 
sidiary companies.  Car  trust  certificates  or  equip- 
ment bonds  may  be  outstanding  covering  the  equip- 
ment of  the  road.  The  terminals  may  have  been 
mortgaged  to  secure  an  issue  of  terminal  bonds. 
Some  of  the  creditors  may  have  reduced  their  claims 
to  judgment,  they  are  then  secured  by  the  lien  of 
their  judgments.  The  interest  on  preferred  stock 
may  have  been  made  a  lien  on  the  property  of  the 
corporation  or  some  of  it.  The  claims  under  pur- 
chase money  mortgages  must  be  considered.  Claims 
for  labor  or  materials  furnished,  under  some  condi- 
tions, are  entitled  to  a  preference  under  the  law  of 
some  of  the  States.  Claims  or  judgments  for  in- 
juries to  persons  or  property  caused  in  the  operation 
of  the  road  by  the  company  are  given  a  preference 
under  the  law  of  some  of  the  States.  Mechanics' 
liens  may  be  charged  against  the  property  of  the  road. 
The  claims  for  operating  expenses,  preferred  by  order 
of  the  court,  and  the  lien  that  the  court  gives  receiv- 
er's certificates  are  matters  for  consideration.  And, 


236  RAILROAD  BONDS  AND  NOTES 

too,  the  claims  for  unpaid  taxes  and  other  govern- 
mental charges,  and  for  the  expenses  of  the  receiver- 
ship and  of  the  trusteeship,  are  to  be  taken  into  ac- 
count, as  they  are  given  a  priority  over  the  other 
indebtednesses  of  the  road.  And  in  addition  to  the 
relative  rights  of  these  secured  creditors  of  different 
kinds  and  ranks,  there  will  be  found  the  general  or 
unsecured  creditors,  including  perhaps  the  holders  of 
notes  or  debentures  of  the  insolvent  road. 

To  the  discussion  of  the  respective  priorities  of 
these  different  classes  of  creditors,  and  their  rights 
in  the  assets  of  the  insolvent  road,  this  chapter  is 
addressed. 

By  priority  in  payment  out  of  certain  property  is 
meant  the  right  to  receive  payment  in  full  out  of 
that  property  before  those  following  next  in  rank 
receive  anything  from  it. 

The  right  to  priority  in  payment  out  of  certain 
property  depends  upon  a  mortgage  or  other  lien 
against  that  specific  property  in  favor  of  the  creditor 
claiming  such  priority. 

Priority  among  several  mortgages  or  other  liens 
depends,  generally  speaking,  upon  the  time  when 
they  attached  to  the  property.  A  mortgage  or  other 
lien  usually  attaches  to  property  at  the  time  when  the 
document  granting  it  is  recorded  in  the  office  of  the 
public  officer  designated  by  law  for  that  purpose. 

The  rights  of  bondholders  and  all  others  secured 
by  mortgage  or  other  lien,  relates  back  to  the  time 


PRIORITIES  OF  THE  OTHER  CREDITORS      237 

when  the  instrument  granting  the  lien  was  recorded. 
Nothing  that  the  railroad  company  can  do  in  the 
way  of  incumbering  the  property  after  that  can  affect 
the  security  that  such  mortgage  or  other  lien  gives. 

There  are  some  claims,  however,  that,  by  reason 
of  their  nature,  are  given  priorities  and  are  sometimes 
preferred  over  some  liens  already  existing.  Re- 
ceivers' certificates  and  sometimes  claims  for  operat- 
ing expenses  come  under  this  heading.  Taxes,  pub- 
lic assessments,  and  other  governmental  charges  are 
always  preferred  and  paid  before  all  other  liens  and 
claims. 

Creditors  having  a  prior  lien  may  waive  it  in  favor 
of  those  having  a  later  lien ;  this  is  sometimes  done  in 
the  reorganization  or  readjustment  of  the  road. 

Claims  of  employees  of  the  road  for  services  ren- 
dered prior  to  the  receivership  in  most  States  are 
given  a  preference.  And  where  such  statutory  pref- 
erence is  not  given,  and  they  are  not  to  be  included 
under  the  head  of  operating  expenses,  they  are 
usually  paid  by  the  receiver  upon  consent  as  a  neces- 
sary expedient  in  continuing  the  road  in  operation 
as  he  depends  upon  their  services  and  skill;  and 
those  who  purchase  the  road  at  foreclosure,  or  reor- 
ganize it,  also  do  so  on  the  ground  that  they  have  the 
advantage  of  a  fully  equipped  complement  of  em- 
ployees to  take  care  of  the  management  and  details 
of  the  road.  Quite  generally  when  the  claims  of 
employees  are  for  the  physical  labor  necessary  to 


238  RAILROAD  BONDS  AND  NOTES 

maintain  and  operate  the  road,  for  the  six  months  or 
any  part  thereof  prior  to  the  receivership,  they  may 
be  given  a  preference.  See  Operating  expenses  prior 
to  receivership,  etc.  Page  245. 

Creditors  on  equal  footing. 

Between  creditors  of  equal  standing,  the  estab- 
lished rule  universally  applied  by  the  courts  is  that 
distribution  shall  be  made  proportionately  among 
them.  Their  rights  are  equal  and  each  shares  pro- 
portionately in  the  fund  to  be  distributed  among 
them  as  a  class. 

Should  there  be  insufficient  to  pay  all  in  any  one 
class,  then  each  of  that  class  bears  the  loss  propor- 
tionately. 

Successive  mortgages  or  other  liens ;  waiving  prior- 
ities. 

As  between  bondholders  or  other  creditors  secured 
by  successive  mortgages  or  other  liens  against  the 
same  property,  the  rule  is  that  the  mortgage  recorded 
first  shall  be  entitled  to  priority  and  the  claims  under 
it  shall  be  paid  first,  in  full,  out  of  that  property 
before  the  claims  under  the  mortgages  or  other  liens 
succeeding  it  shall  receive  anything.  As  to  other 
property  of  the  road  upon  which  they  have  no  lien 
they  stand  on  an  equal  footing. 

The  railroad  company  has  no  power  to  give  to  a 
later  mortgage,  no  matter  for  what  purpose,  any 


PRIORITIES  OF  THE  OTHER  CREDITORS      239 

rights  that  can  supplant  or  displace  the  lien  of  a 
prior  mortgage. 

The  bondholders  under  a  prior  mortgage,  however, 
may  consent  to  waive  their  priority  in  favor  of  a  sub- 
sequent one.  This  is  sometimes  done  in  adjusting 
the  affairs  of  an  insolvent  railroad  company.  These 
bondholders  may  believe  that  the  financial  embar- 
rassments of  the  company  will  be  met  and  overcome 
with  some  assistance  and,  therefore,  do  not  enforce 
their  mortgage,  though  they  have  the  right  to  do  so, 
but  consent  to  give  priority  to  a  later  mortgage  to 
secure  an  issue  of  bonds  or  notes  that  will  raise 
money  to  relieve  the  road  from  what  apparently  is  a 
temporary  stress.  See  Prior  lien  bonds-  preferential 
bonds.  Page  326. 

Only  those  bondholders  under  the  prior  mortgage 
who  consent  will  be  affected.  Those  who  do  not 
consent  will  retain  their  priority.  It  is  a  question  of 
policy  whether  or  not  the  bondholders  will  consent. 
The  trustee  under  the  mortgage  has  no  power  to  bind 
a  bondholder  by  his  consent  in  this  regard. 

Closed  mortgages;  open  end  mortgages;  bonds  in 
series;  open  mortgages. 

Railroad  mortgages  may  be  given  to  secure  a  speci- 
fied or  limited  aggregate  amount  of  bonds,  all  of 
which  are  put  out  at  once.  This  is  termed  a  closed 
mortgage.  The  holders  of  such  bonds  stand  on  an 
equal  footing  and  share  proportionately  in  the  secur- 


240  RAILROAD  BONDS  AND  NOTES 

ity  that  such  mortgage  gives  them  in  the  absence  of 
any  special  arrangement  to  the  contrary. 

An  issue,  however,  may  be  for  a  specified  limited 
aggregate  amount  but  all  the  bonds  may  not  be  put 
out  at  once.  The  mortgage  securing  such  an  issue  is 
called  an  "open  end"  mortgage,  though  technically 
it  is  a  closed  mortgage  as  the  total  aggregate  amount 
is  limited.  The  issue  is  for  an  amount  somewhat 
larger  than  the  present  needs  of  the  railroad  com- 
pany. Its  object  is  to  provide  for  present  purposes 
and  to  avoid  the  necessity  of  another  mortgage  when 
more  money  is  needed  in  the  near  future,  as,  for  in- 
stance, to  retire  underlying  securities  or  to  meet  fu- 
ture requirements  of  the  road.  The  bonds  are  then 
put  out  in  series,  under  the  terms  of  the  mortgage, 
to  meet  the  needs  of  financing  or  equipment  as  they 
arise.  Usually  bonds  for  a  certain  amount  are  put 
out  on  the  execution  and  delivery  of  the  mortgage; 
and  upon  a  specified  later  date,  or  at  the  request  of 
the  board  of  directors  of  the  road,  or  at  such  other 
times  or  upon  such  other  happenings  or  events  as  the 
mortgage  shall  provide,  another  series  in  a  fixed  sum 
is  put  out  and  so  on  until  the  entire  issue  is  nego- 
tiated. All  fall  due  at  the  same  time. 

In  the  absence  of  any  provision  in  the  mortgage  to 
the  contrary,  all  the  bonds  of  such  an  issue  stand 
upon  the  same  footing  without  regard  to  when  they 
were  put  out  or  negotiated.  The  mortgage,  how- 
ever, may  provide  that  bonds  of  one  series  shall  have 


PRIORITIES  OF  THE  OTHER  CREDITORS     241 

priority  over  those  of  another.  As  a  quite  general 
rule  there  is  no  distinction  made. 

Bonds  of  an  issue  of  this  kind  are  to  be  distin- 
guished from  "serial  bonds,"  as  they  are  usually 
called,  which  are  issued  under  a  mortgage  which  pro- 
vides that  each  series  shall  fall  due  at  different  times, 
each  running  for  a  specified  period.  See  Numbered 
bonds.  Page  241. 

Where  a  mortgage  is  made  by  a  railroad  company 
on  its  property  to  secure  bonds,  but  there  is  no 
amount  specified  or  limited,  the  company  may  issue 
as  many  bonds  as  it  desires,  its  only  limitation  being 
that  put  on  it  by  the  statutes  that  exist  in  most  States 
by  which  railroad  companies  shall  not  have  out- 
standing at  any  one  time  a  bonded  indebtedness  be- 
yond a  certain  proportion  of  its  authorized  capital 
stock,  its  paid  in  capital  stock,  or  its  property,  as  the 
case  may  be.  Mortgages  that  contain  no  limitation 
as  to  the  aggregate  amount  are  called  "open  mort- 
gages." They  are  rare. 

Numbered  bonds. 

Railroad  bonds  are  usually  numbered. 

When  numbered  bonds  bear  the  same  date  and  are 
alike  except  as  to  the  numbers,  it  is  presumed  that 
they  are  numbered  not  for  the  purpose  of  giving  one 
number  any  priority  over  another,  but  merely  for 
convenience  in  registration  and  to  aid  identification. 
There  is  then  no  distinction  between  them  and  they 


242  RAILROAD  BONDS  AND  NOTES 

all  stand  on  the  same  footing  and  each  is  entitled  to 
its  proportionate  share  and  rights  in  the  security. 

In  issues  of  railroad  bonds,  numbers  are  often 
given  a  significance  and  form  part  of  the  contract  be- 
tween the  railroad  company  and  the  bondholder. 
This  is  where  the  issue  is  divided  into  classes  and  dis- 
tinguished by  numbers  and  sometimes  by  letters,  and 
one  class  is  given  certain  rights  and  preferences  that 
the  others  do  not  enjoy.  Under  such  an  arrange- 
ment the  bonds  distinguished  by  a  certain  letter,  or 
those  between  certain  numbers,  may  be  redeemable 
and  called  in  before  the  others,  or  they  may  have 
certain  rights  and  privileges  that  the  others  have  not. 

Notwithstanding  these  special  rights  and  privi- 
leges that  they  may  possess  or  those  obligations  they 
may  be  subject  to,  if  there  be  nothing  in  the  mortgage 
to  the  contrary,  these  bonds  are  all  of  equal  standing, 
all  equally  secured  by  the  mortgage,  and  all  are  en- 
titled to  share  proportionately  in  the  security. 
When  serial  bonds,  or  bonds  subject  to  calling  in, 
are  called  in  under  the  provision  to  that  effect  in 
the  mortgage,  it  is  usually  there  provided  that  after 
the  date  on  which  they  should  be  surrendered  or 
fall  due,  they  shall  thereafter  no  longer  be  secured 
by  the  mortgage,  nor  draw  interest  from  such  due 
date.  See  Payment  of  serial  bonds;  bonds  issued 
in  series.  Page  100.  See  also  Redeeming  bonds  or 
calling  bonds  in.  Page  98. 

Serial  bonds  are  to  be  distinguished  from  bonds 


PRIORITIES  OF  THE  OTHER  CREDITORS     243 

issued  in  series.  The  terms  are  not  always  accu- 
rately employed.  In  the  case  of  bonds  issued  in 
series,  they  all  fall  due  on  the  same  date,  though 
they  are  put  out  at  different  times;  in  the  case  of 
serial  bonds,  they  are  all  put  out  at  the  same  time,  or 
at  such  times  as  the  mortgage  shall  provide,  but  they 
fall  due  in  series  at  certain  specified  times,  each 
series  running  for  a  different  period. 

Over-issued  bonds. 

Railroad  bonds  are  sometimes  issued  in  excess  of 
the  amount  to  which  the  issue  is  limited.  The  over- 
issued bonds  are  good  in  the  hands  of  a  bona  fide 
holder  who  has  paid  value  and  bought  them  in  the 
usual  course  of  business  before  their  maturity,  in 
good  faith,  and  without  notice  or  knowledge  that 
there  was  anything  wrong.  A  bondholder  meeting 
all  these  requirements  is  entitled  to  have  his  bonds, 
though  over-issued,  share  proportionately  in  the  se- 
curity of  the  mortgage. 

Over-issued  bonds  are  void  in  the  hands  of  one 
who  is  not  a  bona  fide  purchaser,  as  just  described. 
See  Validity  of  bonds.  Page  18.  See  also  Trus- 
tee's certificate.  Page  70. 

Re-issued   bonds;   exchanged   bonds;   substituted 
bonds. 

Unless  forbidden  by  its  charter  or  by  law,  a  rail- 
road company  may  buy  in  its  own  bonds  and  re- 


244  RAILROAD  BONDS  AND  NOTES 

issue  them.  Such  bonds  when  re-issued  possess  the 
same  rights  under  the  mortgage  that  they  had  before 
the  railroad  company  acquired  and  put  them  out 
again. 

Sometimes  in  the  adjustment  of  the  affairs  of  a 
railroad  company,  the  bonds  of  an  issue  secured  by  a 
mortgage  may  be  exchanged  for  bonds  of  a  new  issue. 
The  question  may  then  present  itself:  Are  the  new 
bonds  secured  by  that  mortgage'? 

This  depends  entirely  upon  the  intention  of  the 
parties  when  the  exchange  was  made  as  shown  by  the 
facts  and  circumstances  surrounding  the  transaction. 
If  it  was  intended  that  the  whole  debt  secured  by  the 
mortgage  should  continue,  then  the  transaction  is 
merely  a  substitution  of  the  new  bonds  for  the  old 
ones,  and  the  new  bonds  are  entitled  to  all  the  rights 
under  the  mortgage  that  the  original  bonds  had. 
The  mortgage  continues  to  secure  the  old  debt  which 
has  now  taken  a  new  form.  However,  if  the  inten- 
tion was  that  the  debt  evidenced  by  the  old  bonds 
was  to  be  extinguished,  and  the  new  bonds  were 
issued  not  in  exchange  but  in  payment  of  them,  then 
the  original  mortgage  does  not  secure  such  new  bonds. 
The  instances  discussed  are  those  where  one  issue  is 
exchanged  for  another,  and  do  not  have  reference  to 
the  exchanging  of  a  coupon  bond  for  a  registered 
bond,  or  vice  versa,  as  is  usually  permitted.  They 
are  of  the  same  issue. 


PRIORITIES  OF  THE  OTHER  CREDITORS     245 

New  mortgage  before  all  bonds  under  prior  mort- 
gage are  put  out. 

Before  all  the  bonds  secured  by  a  railroad  mort- 
gage are  put  out,  a  new  issue  may  be  made  and  be 
secured  by  a  mortgage  which  is  a  later  lien.  All  the 
bonds  under  the  first  mortgage  are  entitled  to  the 
protection  of  its  lien,  no  matter  when  they  were  put 
out  or  negotiated,  in  the  absence  of  any  understand- 
ing to  the  contrary;  and  as  its  lien  is  prior  to  that  of 
the  later  mortgage,  the  holders  of  the  bonds  of  such 
first  issue,  who  receive  their  bonds  before  their  ma- 
turity, though  after  the  execution  and  recording  of 
the  later  mortgage,  are  entitled  to  priority  over  the 
holders  of  the  later  issue. 

The  later  issue  does  not  operate  to  retire  the  bonds 
of  the  prior  issue  not  yet  put  out.  The  holders  of 
the  bonds  of  the  later  issue  might  have  protected 
themselves  as  against  the  bonds  of  the  prior  issue 
not  yet  put  out,  by  demanding  that  they  be  destroyed 
before  their  issue  is  negotiated. 

Operating  expenses  prior  to  receivership ;  nature  of 
claims  entitled  to  this  preference ;  six  months' 
rule;  extent  of  preference;  reasons  therefor; 
funds  affected  by  the  preference. 

It  is  well  settled  in  this  country  that  the  claims 
for  operating  expenses  incurred  by  the  railroad  com- 
pany before  the  receivership  may  be  given  a  prefer- 
ence over  the  claims  of  the  other  creditors  of  the  rail- 


246  RAILROAD  BONDS  AND  NOTES 

road  company,  with  regard  to  the  income  of  the  road 
and  perhaps  the  mortgaged  property  itself. 

They  are  paid  in  full  out  of  the  income  in  the 
hands  of  the  receiver  before  the  bondholders  under 
the  foreclosed  mortgage  or  other  creditors  receive 
anything.  And  should  the  income  earned  by  the 
company  have  been  diverted  from  the  payment  of 
current  expenses  to  the  improvement  of  the  mort- 
gaged property,  then  the  operating  expenses  are  given 
the  same  preference  with  respect  to  the  proceeds  of 
the  sale  of  the  property  itself,  to  the  extent  of  the 
moneys  so  diverted. 

Generally  speaking,  the  claims  for  operating  ex- 
penses that  come  under  this  rule  are  those  for  services 
rendered  or  materials  furnished  to  the  railroad,  and 
necessary  for  its  maintenance  and  operation,  within 
six  months  prior  to  the  receivership. 

This  rule  has  been  molded  by  the  necessities  of  the 
complex  situation  that  confronts  the  court  in  adjust- 
ing the  affairs  of  the  insolvent  railroad  company.  It 
finds  its  justification  on  the  grounds  of  equity  and 
public  policy. 

It  is  not  lightly  that  the  court  will  displace  the  lien 
of  the  bondholders  in  favor  of  claims  for  operating 
expenses,  and  the  tendency,  therefore,  is  to  give  the 
term  a  narrow  application.  Accordingly,  claims  for 
services  in  order  to  come  under  the  rule  are  limited  to 
those  of  operatives  and  employees  engaged  in  the 
manual  labor  of  running  the  road  or  making  repairs 


PRIORITIES  OF  THE  OTHER  CREDITORS      247 

on  it.  A  distinction  is  drawn  against  the  services  of 
a  financial  or  executive  officer  who  may  be  regarded 
as  an  employer  in  operating  the  road.  Only  those 
who  actually  do  the  physical  work  are  entitled  to  this 
preference ;  and  the  claims  for  services  of  those  acting 
in  a  supervisory  capacity,  though  employees  of  the 
company,  are  not  classed  as  operating  expenses. 

Claims  for  materials  furnished  are  governed  by 
substantially  the  same  rule.  To  come  within  the 
rule,  the  materials  furnished  must  have  been  indis- 
pensable in  making  repairs  necessary  for  the  mainte- 
nance and  operation  of  the  road  or  its  equipment. 

After  complying  with  these  requirements  as  to  the 
nature  of  the  work  or  the  kind  of  materials,  it  is 
necessary  too  that  they  should  have  been  rendered  or 
should  have  been  supplied  within  six  months  prior  to 
the  receivership.  The  court  may  fix  this  period  at 
more  or  less  than  six  months.  Its  action  is  based 
upon  the  conditions  that  confront  it.  As  a  general 
rule  six  months  is  specified. 

The  theory  upon  which  the  court  works  out  the 
equity  of  the  preference  is  that  had  the  road  con- 
tinued in  operation  it  would  have  paid  these  operat- 
ing expenses  from  its  earnings;  but  having  with- 
held them,  those  entitled  thereto  may  follow  and 
claim  them. 

Current  income  should  be  applied  to  current  ex- 
penses. The  bondholders  should  have  received  only 
the  net  income,  what  is  left  after  these  expenses  are 


248  RAILROAD  BONDS  AND  NOTES 

paid,  in  payment  of  their  interest.  Railroad  com- 
panies usually  get  their  labor,  supplies,  equipment 
and  improvements  on  credits  of  varying  periods,  and 
when  it  becomes  financially  embarrassed  these  debts 
are  allowed  to  accumulate  for  a  period,  usually,  of 
about  six  months  prior  to  the  receivership,  and  the 
earnings  of  the  road  during  that  time,  which  should 
have  been  applied  to  their  payment,  is  usually  used 
to  pay  interest  on  bonds  to  prevent  or  postpone  a 
foreclosure  or  other  legal  action.  These  earnings  for 
that  period  should  not  be  used  for  interest  on  bonds 
until  all  the  current  expenses  of  that  period  are  paid 
in  full. 

The  rule,  too,  finds  its  vindication  on  grounds  of 
public  policy.  The  rights  of  bondholders  under 
railroad  mortgages  involve  considerations  that  are 
peculiar  to  that  class  of  securities  and  which  do  not 
enter  into  the  case  of  bonds  secured  by  mortgage  on 
other  property.  This  results  from  the  fact  that  a 
railroad  company,  though  an  association  of  private 
individuals  organized  for  private  gain,  is,  in  its  rela- 
tion to  the  public,  a  quasi  public  corporation.  The 
public  is  concerned  with  the  franchise  of  a  railroad 
company  and  vitally  and  immediately  interested  that 
it  shall  be  continued  in  operation.  And  all  persons 
who  become  holders  of  railroad  bonds  are  held  to 
have  accepted  them  and  otherwise  to  have  dealt  with 
the  corporation  with  the  implied  consent  that  should 
it  fall  into  insolvency  and  its  affairs  be  administered 


PRIORITIES  OF  THE  OTHER  CREDITORS      249 

by  the  courts,  then  those  debts  necessarily  incurred 
for  the  purpose  of  continuing  the  road  in  operation 
and  carrying  out  the  objects  for  which  the  company 
was  created,  may  be  given  priority  over  their  own 
claims. 

This  priority  is  limited,  ordinarily,  to  the  income 
in  the  hands  of  the  receiver;  but,  where  the  income 
of  the  road  prior  to,  or  during,  the  receivership  has 
been  used  to  improve  the  mortgaged  property,  then 
claims  for  operating  expenses  are  charged  against  the 
mortgaged  property  thus  improved,  to  the  extent  of 
the  income  that  was  used  to  pay  for  such  improve- 
ments. Under  these  circumstances,  operating  ex- 
penses to  the  extent  of  the  amount  that  has  been  thus 
diverted  are  ordered  paid  out  of  the  proceeds  of  the 
mortgaged  property  before  the  bondholders  or  other 
creditors  receive  anything  therefrom.  It  must  be 
shown  that  the  income  was  diverted  to  the  improve- 
ment of  the  mortgaged  property  and  from  the  pay- 
ment of  the  current  expenses,  before  such  property 
itself  will  be  charged  with  their  payment,  otherwise 
the  preference  in  favor  of  operating  expenses  is  lim- 
ited to  the  income.  Should  there  be  no  income  and 
no  diversion,  then  claims  for  operating  expenses 
prior  to  the  receivership  have  no  preference  and  are 
paid  like  general  or  unsecured  creditors,  unless  they 
are  otherwise  secured  or  preferred. 

Claims  against  the  receiver  for  services  rendered 
or  materials  furnished  during  the  receivership  are 


250  RAILROAD  BONDS  AND  NOTES 

differently  considered ;  they  are  regarded  as  expenses 
of  the  receivership  and,  as  such,  are  paid  in  full 
before  the  bondholders  or  other  creditors  receive  any- 
thing. 

In  many  of  the  states  there  are  statutes  to  the  effect 
that  claims  for  labor  performed  and  for  materials 
furnished  to  the  railroad  company  necessary  to  con- 
struct, alter  or  repair  the  road  shall  be  entitled  to  a 
lien  on  the  property  of  the  railroad  company,  so  af- 
fected, and  shall  be  entitled  to  a  preference  over  any 
mortgage  covering  the  same  property  given  subse- 
quent to  the  time  when  the  lien  attached  protecting 
such  work  or  materials  furnished.  See  Mechanics' 
liens.  Page  252. 

Claims  for  original  construction. 

Bondholders  are  entitled  to  be  paid  in  full  out  of 
the  proceeds  of  the  property  that  has  been  mortgaged 
to  them  before  the  claims  of  those  who  built  the  road, 
either  before  or  after  their  mortgage  was  given,  re- 
ceive anything;  unless  the  claims  for  such  original 
construction  are  protected  by  mortgage  or  other  lien. 
Should  such  claim  be  protected  by  mortgage  or  lien 
it  then  becomes  a  question  of  the  priority  of  the  re- 
spective liens.  See  What  is  meant  by  priority. 
Page  236. 

Experience  has  shown  that  public  and  private  in- 
terests demand  that  in  the  building  of  a  railroad  the 
moneys  for  that  purpose  shall  be  fully  and  ade- 


PRIORITIES  OF  THE  OTHER  CREDITORS      251 

quately  provided  for  before  the  commencement  of 
the  work.  Obligated  to  the  State  to  serve  the  public, 
the  railroad  company  may  not  permit  its  property 
and  franchise  to  lie  dormant  in  disuse.  It  must  go 
forward  with  the  enterprise  in  the  reasonable  expec- 
tation of  being  able  to  pay  the  mortgage  and  costs  of 
construction  and  realize  to  the  public  and  to  itself 
the  legitimate  benefits  of  the  undertaking.  If  money 
be  not  raised  by  the  sale  of  bonds,  the  enterprise 
would  stop  immediately,  and  the  labor  and  materials 
already  furnished  would  lose  their  greater  value  and 
the  opportunity  to  earn  the  money  to  pay  for  them 
would  also  go.  If  the  bondholders  do  not  advance 
their  money  at  this  critical  time,  all  that  had  been 
done  would  greatly  diminish  in  value  if  not  be  lost. 

And  the  efforts  that  have  been  made  to  obtain  for 
the  claims  for  original  construction  of  the  road  a 
preference,  because  they  furnished  by  their  labor  and 
materials  the  very  property  which  is  mortgaged  to 
the  bondholders,  finds  no  foundation. 

Those  supplying  the  materials  and  labor  for  the 
original  construction  of  the  road  might  protect  them- 
selves by  a  mortgage :  but  the  presence  of  a  mortgage 
to  secure  the  claims  for  original  construction  would 
interfere  with  later  and  necessary  financing.  And 
it  seems  no  hardship  that  the  claims  for  original  con- 
struction of  the  mortgaged  property  should  be  paid 
out  of  that  property  after  the  claims  of  the  bond- 
holders secured  by  mortgage  on  it,  as  it  is  the  money 


252  RAILROAD  BONDS  AND  NOTES 

the  latter  supply  that  makes  the  labor  and  materials 
of  the  former  productive  and  of  practical  value. 

In  some  of  the  States,  however,  there  are  statutes 
that  give  contractors  and  those  supplying  materials 
and  labor  for  the  original  construction  of  a  railroad 
a  preference  in  payment  out  of  the  assets  of  the  corpo- 
ration over  a  mortgage  upon  the  road  executed  later. 

Sometimes  the  claims  for  original  construction  of 
the  road,  or  for  permanent  repairs,  may  take  the  form 
of  claims  for  operating  expenses  and,  as  such,  receive 
a  preference.  See  Operating  expenses.  Page  245. 

Mechanics'  liens. 

As  a  rule,  mechanics'  liens  do  not  affect  railroad 
property  unless  the  statute  giving  the  lien  specifically 
declares  that  it  shall  include  railroad  property. 

A  lien  is  sometimes  given  by  statute  to  those  who 
furnish  materials  or  render  labor  in  the  constructing, 
repairing  or  altering  of  the  property  of  a  railroad. 
These  statutes  declare  that  within  a  limited  time, 
usually  ninety  days,  after  the  last  item  of  work  has 
been  done  or  piece  of  material  has  been  furnished,  a 
written  statement  of  the  claim  must  be  filed  in  the 
office  of  the  public  officer  designated,  usually  the 
clerk  of  the  county  where  the  property  is  situated 
upon  which  the  lien  is  claimed. 

From  the  time  this  statement  is  filed  the  lien  at- 
taches to  the  property  that  was  benefited  by  the  labor 
or  materials,  and  such  lien  takes  priority  over  any 


PRIORITIES  OF  THE  OTHER  CREDITORS      253 

mortgage  or  other  lien  subsequently  attaching  to  the 
property.  However,  as  was  stated,  a  mechanics'  lien 
does  not  apply  to  the  property  of  a  railroad  unless 
the  statute  which  gives  the  lien  says  that  it  shall. 

Attachments  and  executions  against  property  of 
the  road. 

As  a  railroad  is  charged  with  its  duty  to  the  public 
to  continue  in  operation,  an  attachment  or  execution 
may  not  be  levied  against  such  of  its  property,  or 
under  such  conditions  as  will  interfere  with  the  per- 
formance of  such  public  duties;  a  receiver  will  then 
be  appointed.  An  attachment  or  execution,  how- 
ever, may  be  levied  against  the  property  of  a  rail- 
road where  it  does  not  interfere  with  its  operation. 
See  Judgments.  Page  258. 

An  attachment  against  property  is  the  legal  process 
whereby  property  of  a  party  to  the  suit,  at  the  in- 
stance of  the  opposing  party,  is  taken  during  the 
progress  of  civil  litigation,  and  is  held  to  await  the 
final  determination  of  the  rights  of  the  parties. 
Should  the  party  at  whose  instance  such  property  was 
seized  be  successful  in  such  suit,  he  may  then  take 
such  property  so  attached  and  apply  it  to  the  pay- 
ment of  the  judgment  he  has  obtained.  It  is  a  means 
of  seizing  property,  at  the  commencement  of  litiga- 
tion, to  insure  payment  of  a  judgment  and  also  so 
that  its  owner  cannot  remove  or  dispose  of  it,  and 
thus  defeat  subsequent  proceedings  against  it. 


254  RAILROAD  BONDS  AND  NOTES 

Should  the  party  at  whose  instance  such  property 
was  attached  be  defeated  in  the  final  outcome  of 
the  suit  he  must  pay  the  owner  of  such  property 
damages  for  its  wrongful  seizure  and  detention. 

An  execution  against  property  is  the  final  process 
in  a  civil  suit  whereby  the  property  of  the  defeated 
party  is  taken  by  the  officer  designated  by  law  for 
that  purpose,  usually  the  sheriff,  to  satisfy  the  judg- 
ment that  has  been  rendered  in  favor  of  the  successful 
party. 

Preferred  stock. 

The  claims  of  bondholders  under  a  mortgage  are 
prior,  ordinarily,  to  those  of  the  holders  of  preferred 
stock,  for  both  principal  and  interest.  However, 
preferred  stock  may  be  issued  under  an  agreement 
that  the  dividends  payable  on  it  shall  be  a  charge 
against  the  property  of  the  road,  prior  to  all  indebt- 
ednesses subsequently  created.  In  such  a  case,  a 
mortgage  executed  by  the  railroad  company,  after 
such  an  agreement  is  of  record,  is  subordinate  or 
junior  to  the  claims  for  such  dividends  so  secured. 

Taxes,  public  assessments,  governmental  charges. 

The  lien  of  the  bondholders  under  their  mortgage 
and  the  claims  of  all  other  creditors  are,  as  a  general 
rule,  deferred  to  the  indebtednesses  of  the  corpora- 
tion for  unpaid  taxes,  public  assessments,  or  other 
governmental  charges.  Money  due  for  the  pur- 


PRIORITIES  OF  THE  OTHER  CREDITORS      255 

poses  mentioned  are  declared  by  statute  to  be  liens 
upon  the  property  of  the  person  or  corporation  owing 
it.  The  superior  standing  of  indebtednesses  of  this 
character  is  always  recognized  by  the  courts  and 
they  are  paid  in  full,  no  matter  when  they  accrued, 
before  any  other  creditors  receive  anything. 

The  lien  for  claims  of  the  kind  under  discussion 
do  not  displace  the  lien  of  the  mortgage  of  the  bond- 
holders, unless  the  statute  imposing  such  tax,  or 
other  enactment,  declares  it  shall;  these  statutes 
invariably  declare,  however,  that  the  liens  for  charges 
of  the  nature  mentioned  shall  be  superior  to  all  other 
liens  against  the  property. 

Purchase  money  mortgages;  conditional  sales. 

The  mortgage  that  the  railroad  company  may 
execute  to  secure  the  unpaid  balance  of  the  purchase 
price  of  property  that  it  may  acquire,  is  superior  to 
any  mortgage  or  other  lien  that  the  railroad  company 
may  execute  or  create,  or  may  have  executed  or  cre- 
ated against  such  property,  either  before  or  after  such 
purchase  money  mortgage  was  given. 

Therefore,  property  falling  under  the  lien  of  a 
mortgage  already  existing  against  the  road  with  the 
after  acquired  property  clause,  must  first  satisfy  in 
full  a  purchase  money  mortgage  before  its  proceeds 
shall  be  applied  to  the  satisfaction  of  the  claims 
under  such  mortgage  with  the  after  acquired  prop- 
erty clause. 


256  RAILROAD  BONDS  AND  NOTES 

The  theory  of  law  upon  which  this  conclusion  is 
reached  is  that  the  railroad  company  never  was  pos- 
sessed of  that  portion  of  the  property  covered  by  the 
purchase  money  mortgage;  and  the  railroad  company 
gets  this  property  subject  to  such  purchase  money 
mortgage;  it  has  attached  to  the  property  before  the 
railroad  company  got  it,  and  whatever  it  may  have 
done  or  may  do  in  the  future  is  subject  to  such  pur- 
chase money  mortgage. 

A  similar  result  is  produced  by  the  arrangement 
known  as  the  "conditional  sale." 

Property  may  be  sold  to  the  railroad  company  with 
the  condition  that  the  party  selling  it  shall  retain 
the  title  and  ownership  until  the  purchase  price  has 
been  paid  in  full,  but  that  the  railroad  company  may, 
in  the  meantime,  have  possession  and  use  of  the 
property.  This  is  a  conditional  sale  in  which  the 
passing  of  title  and  ownership  are  conditional  upon 
the  payment  of  the  full  purchase  price. 

As  the  corporation  can  mortgage  only  those  inter- 
ests in  property  that  it  has,  its  mortgage  does  not 
include  such  property  purchased  on  conditional  sales, 
as  it  has  no  interest  in  that  property,  such  as  can  be 
the  subject  of  a  mortgage,  until  it  has  paid  the  pur- 
chase price  in  full  and  acquires  title.  Should  there 
be  an  after  acquired  property  clause  in  the  mortgage, 
it  covers  such  property  only  when  the  railroad  ulti- 
mately acquires  the  title  to  it.  See  Car  trust  certifi- 
cates or  bonds.  Page  316. 


PRIORITIES  OF  THE  OTHER  CREDITORS      257 

The  difference  between  the  two  instances  is  that  in 
the  purchase  money  mortgage  the  railroad  company 
acquires  the  title  and  ownership  of  the  property  im- 
mediately, subject  to  the  superior  lien  of  the  pur- 
chase money  mortgage ;  while  in  the  conditional  sale 
the  title  and  ownership  to  the  property  continues  in 
the  seller  until  the  full  purchase  price  is  paid,  though 
the  railroad  company  may  have  possession  and  use 
of  it  in  the  meanwhile. 

Right  of  way  claims. 

Land  may  be  taken  from  owners  against  their  wills 
for  public  purposes.  As  railroads  are  regarded  as 
quasi  public  corporations,  land  may  be  taken  thus 
for  rights  of  way  for  railroads. 

The  right  to  take  land  under  these  circumstances 
lies  in  the  State  by  reason  of  its  sovereign  power. 
This  is  called  the  "right  of  eminent  domain."  The 
value  of  the  land  so  taken  is  appraised  and  such  sum 
paid  to  the  owner.  He  and  his  experts  have  an  op- 
portunity to  be  heard.  The  proceedings  under 
which  the  land  is  thus  taken,  and  its  value  fixed  and 
paid,  are  called  "condemnation  proceedings." 

Owners  of  adjacent  land  which  has  been  harm- 
fully affected  by  the  road  running  near  it,  though 
such  land  has  not  been  actually  taken,  are  entitled 
to  damages  to  the  amount  that  the  property  has  been 
diminished  in  value. 

When  a  railroad  includes  a  right  of  way  in  its 


258  RAILROAD  BONDS  AND  NOTES 

mortgage  there  may  be  a  conflict  as  to  priority  be- 
tween bondholders  under  that  mortgage  and  those 
from  whom  the  right  of  way  was  acquired. 

Those  from  whom  land  for  rights  of  way  was  ac- 
quired under  these  proceedings  are  entitled  to  a  pref- 
erence for  the  unpaid  price,  or  any  portion  of  it,  over 
all  mortgages  of  the  railroad  company.  Claims  for 
damages  to  adjoining  owners  against  the  railroad 
company  arising  out  of  the  obtaining  by  it  of  a  right 
of  way,  though  their  property  was  not  actually  taken, 
are  given  a  like  preference. 

However,  should  the  right  of  way  be  purchased 
with  money  that  is  loaned  to  the  railroad  company, 
the  party  loaning  the  money  for  that  purpose  is  not 
entitled  to  any  preference.  His  relation  is  that  of 
one  who  has  loaned  money  to  the  company  and  not 
that  of  one  from  whom  the  right  of  way  was  ac- 
quired. 

Judgments. 

The  claims  of  the  bondholders  under  their  mort- 
gage are  entitled  to  payment  in  full  out  of  the  mort- 
gaged property  before  judgments  against  the  road 
receive  anything  from  that  property,  where  the  judg- 
ments were  recovered  and  docketed  after  the  mort- 
gage was  recorded  or  filed.  If  the  judgment  was 
docketed  before  the  mortgage  was  recorded,  then  it  is 
entitled  to  be  paid  in  full  out  of  the  property  of  the 
road,  including  the  mortgaged  property,  before  the 


PRIORITIES  OF  THE  OTHER  CREDITORS     259 

bondholders  receive  anything  from  the  property  cov- 
ered by  their  mortgage. 

Whether  the  mortgage  or  the  judgment  has  pri- 
ority in  payment  out  of  the  proceeds  of  certain  prop- 
erty depends  upon  which  was  made  a  public  record 
first,  by  filing  or  recording  in  the  case  of  the  mort- 
gage, or  docketing  in  the  case  of  the  judgment. 

The  docketing  of  a  judgment  in  the  office  of  the 
public  official  designated  therefor,  usually  the  clerk 
of  the  county  wherein  the  judgment  was  obtained, 
makes  that  judgment  a  lien  against  the  real  estate 
of  the  railroad  company  situated  within  that  county. 
Transcripts  of  the  judgment  may  be  docketed  in  each 
county  in  which  the  railroad  company  has  property, 
and  thus  become  liens  against  its  property  in  each  of 
such  counties. 

Both  the  docketed  judgment  and  the  filed  or  re- 
corded mortgage  create  liens  against  the  real  estate 
of  the  railroad  company.  The  lien  of  the  judgment 
attaches  to  all  the  real  estate  of  the  corporation  situ- 
ated in  the  counties  in  which  the  judgment  is  dock- 
eted; while  the  lien  of  the  mortgage  attaches  only 
to  the  property  that  is  pledged  by  the  mortgage. 
See  Attachments  and  Executions.  Page  253. 

Claims  and  judgments  growing  out  of  injuries 
caused  persons  or  property  while  the  receiver  oper- 
ated the  road  are  regarded  as  expenses  of  the  receiv- 
ership and  therefore  are  paid  in  full  before  the  claims 
under  any  mortgage  receive  anything. 


260  RAILROAD  BONDS  AND  NOTES 

Claims  and  judgments  for  injuries  to  persons  or 
property. 

All  claims  for  damages  arising  out  of  the  trans- 
portation of  persons  or  property  while  the  railroad 
company  operated  the  road  are,  as  a  general  rule, 
classed  as  general  or  unsecured  debts  of  the  road. 

In  a  few  States  judgments  for  damages  to  per- 
sons or  property  sustained  while  the  railroad  com- 
pany operated  the  road,  constitute  a  lien  on  all  its 
property,  from  the  time  the  injury  was  inflicted,  and 
are  entitled  to  be  paid  in  full  out  of  such  property, 
including  that  covered  by  mortgages,  before  the 
bondholders  under  such  mortgages  receive  anything. 
In  the  absence  of  such  a  statute  law  this  right  to  a 
preference  does  not  exist. 

Claims  or  judgments  against  the  receiver,  how- 
ever, for  injuries  or  damages  to  persons  or  property 
during  the  operation  of  the  road  by  him  stand  upon 
a  different  footing  and  are  paid  as  expenses  of  the 
receivership,  and  are  paid  therefore  in  full  before  the 
bondholders  under  their  mortgage  receive  anything. 

Priorities  among  interest  coupons  and  claims  for 
interest;  between  principal  and  interest. 

Interest  coupons  or  claims  for  interest  are,  ordi- 
narily, not  entitled  to  priority  over  the  principal  of 
the  bonds.  Nor  are  interest  coupons  or  claims  for 
interest,  as  among  themselves,  entitled  to  any  pref- 
erence because  one  matures  before  the  other.  How- 


PRIORITIES  OF  THE  OTHER  CREDITORS      261 

ever,  overdue  coupons  have  been  given  a  preference 
over  their  bonds  which  have  not  matured,  when  a 
part  of  the  series  of  coupons  to  which  they  belong 
had  already  been  paid. 

Railroad  mortgages  usually  provide  that  all  in- 
terest coupons  and  claims  for  interest  shall,  under 
all  circumstances,  share  equally  in  the  proceeds  of 
the  mortgaged  property;  and  that  when  the  princi- 
pal of  the  bonds  becomes  due  (for  any  reason)  that 
the  coupons  and  the  claims  for  interest  and  the 
claims  for  the  principal  of  the  bonds  shall  all  stand 
on  the  same  footing  and  be  paid  without  preference 
of  one  over  the  other.  However,  railroad  mort- 
gages may  properly  make  provision  for  a  priority 
among  the  coupons  and  principal  and,  as  is  some- 
times the  case,  declare  that  coupons  shall  be  entitled 
to  a  priority  according  to  the  dates  of  their  maturi- 
ties. Sometimes  a  railroad  mortgage  will  contain 
a  provision  that  the  coupons  shall  be  paid  before  the 
principal  of  the  bond.  Such  arrangements  or  any 
other  that  the  parties  shall  agree  upon  will  be  car- 
ried out  by  the  court. 

The  usual  form  of  railroad  mortgage  contains  the 
stipulation  that  when  the  coupons  are  paid  they  shall 
be  canceled.  This  is  done  because  a  third  party  may 
have  advanced  the  money  to  the  railroad  company 
with  which  to  pay  the  coupons  and  may  then  hold 
them  against  the  railroad  company  as  its  unpaid 
outstanding  obligations.  To  permit  such  third  party 


262  RAILROAD  BONDS  AND  NOTES 

to  keep  alive  these  coupons  would  enable  him  to 
prove  them  in  competition  with  the  holders  of  the 
bonds  and  of  the  other  coupons  under  the  mortgage 
and  to  share  with  them  in  the  security,  and  thereby 
lessen  their  respective  shares  in  the  proceeds  of  the 
mortgaged  property.  Hence  this  provision  that 
when  paid,  the  coupons  shall  be  canceled  so  far  as 
the  holders  of  the  bonds  and  other  coupons  are  con- 
cerned. But  as  between  the  railroad  company  and 
the  party  paying  off  such  coupons  in  its  behalf,  the 
coupons  may  be  kept  alive  as  evidence  of  the  debt 
the  railroad  company  owes  such  third  party  for  the 
money  so  advanced.  See  Effect  of  payment  on  cou- 
pons. Page  38. 

Notes ;  debentures  or  unsecured  bonds. 

When  a  railroad  company  has  the  power  to  issue 
written  obligations  for  the  payment  of  its  debts,  the 
particular  form  such  obligation  shall  take  is  a  mat- 
ter that  the  corporation  itself  may  regulate.  It  may 
issue  bonds  or  notes,  and  may  or  may  not  secure  them 
by  mortgage  or  otherwise. 

A  note  is  the  written  promise  of  the  railroad  com- 
pany to  pay  a  certain  principal  sum  with  the  date  of 
payment,  rate  of  interest,  and  the  times  for  the  pay- 
ment of  the  interest  specified  in  the  note.  The  notes 
may  be  in  coupon  form  and  may  have  coupons  at- 
tached, the  same  as  bonds  have,  for  the  different 
instalments  of  interest.  The  same  rules  in  all  re- 


PRIORITIES  OF  THE  OTHER  CREDITORS      263 

spects  apply  to  the  principal  and  coupons  of  notes 
that  apply  to  the  principal  and  coupons  of  bonds. 

There  is  no  difference  between  a  note  and  a  bond 
in  their  respective  natures,  as  each  is  the  written 
promise  of  the  issuing  company  to  pay  according  to 
the  tenor  of  their  respective  terms;  nor  is  there  any 
difference  between  the  coupons  of  each,  in  their  re- 
spective natures.  See  Notes  and  bonds  compared. 
Page  11. 

Notes  of  a  railroad  company  may  be  secured  by 
a  mortgage  on  its  property,  or  they  may  be  other- 
wise secured.  The  same  rules  apply  to  the  mort- 
gages or  other  security  for  notes  as  apply  to  mort- 
gages or  other  security  for  bonds  under  like  condi- 
tions. It  seems  the  custom,  however,  to  issue  notes 
without  security  of  any  kind  other  than  the  credit 
and  standing  of  the  issuing  company,  and  its  general 
ownership  of  property,  without  creating  any  specific 
lien  thereon  in  favor  of  the  notes. 

Notes  are  usually  issued  for  shorter  periods  than 
bonds.  When  they  are  issued  for  longer  periods  and 
are  not  secured  they  are  referred  to  as  debentures. 

In  the  United  States,  the  term  "debenture"  is 
generally  used  to  designate  a  bond  that  is  unsecured 
by  mortgage  or  any  collateral.  It  is  a  plain  bond 
containing  a  promise  by  the  railroad  company  that 
issues  it  to  pay  a  specified  sum  with  interest,  at  a 
certain  date. 

The  term  as  used  in  the  United  States  should  not 


264  RAILROAD  BONDS  AND  NOTES 

be  confused  with  the  meaning  given  to  it  in  other 
countries.1  In  the  United  States  a  debenture  is 
generally  understood  to  mean  an  unsecured  bond. 

The  holder  of  an  unsecured  note  or  an  unsecured 
debenture  of  a  railroad  company  stands  upon  the 
same  footing  as  any  other  general  or  unsecured  cred- 
itor of  the  corporation.  He  shares  proportionately 
with  all  other  general  or  unsecured  creditors  in  the 
property  upon  which  there  is  no  mortgage  or  other 
lien.  He  has  no  recourse  to  any  property  of  the 
railroad  company  that  is  covered  by  a  mortgage  or 
other  lien,  until  all  the  claims  represented  by  such 
mortgages  or  other  liens  have  been  satisfied  in  full 
out  of  such  property.  He  then  shares  proportion- 
ately in  what  remains  of  such  property  after  such 
mortgages  or  other  liens  have  been  satisfied  in  full. 

Should  the  bondholders  or  other  creditors  secured 
by  mortgages  or  other  liens  against  specific  pieces  of 
property  find  that  after  such  property  has  been  real- 
ized upon  there  is  a  deficit,  then  for  such  balance  of 
their  claims  remaining  unpaid,  they  become  general 
or  unsecured  creditors  and,  as  such,  are  entitled  to 
share  proportionately  with  the  unsecured  debenture 
holders  and  unsecured  noteholders  and  all  other  un- 
secured creditors  in  such  funds  as  the  latter  class  of 
creditors  have  access  to.  See  Secured  and  unsecured 
creditors.  Page  227.  See  also  Difference  between 
bondholders  and  stockholders.  Page  15. 

1  See  footnote,  pages  n  and  12. 


PRIORITIES  OF  THE  OTHER  CREDITORS      265 

Debenture  holders  and  unsecured  noteholders  are 
entitled  to  be  paid  in  full  before  the  stockholders 
receive  anything. 

In  many  issues  of  debenture  bonds  and  of  notes 
that  are  unsecured,  the  railroad  company  stipulates 
that  it  will  create  no  mortgage  or  other  lien  on  its 
property  to  secure  any  subsequent  issue  of  bonds  or 
other  securities  that  will  give  such  subsequent  issue 
priority  over  or  equality  with  the  holders  of  such 
debentures  or  notes.  Sometimes  the  provision  is 
that,  should  a  mortgage  be  subsequently  given  to 
secure  a  later  issue  of  securities,  the  holders  of  such 
notes  or  debentures  shall  share  in  the  security  such 
mortgage  gives  equally  with  the  holders  of  the  se- 
curities issued  under  it. 

The  standing  of  the  debentures  and  of  the  notes 
and  of  the  property  of  the  road  is  not  disturbed  but 
is  thus  kept  as  it  was  when  such  notes  or  debentures 
were  issued;  in  this  way  the  debentures  or  notes  are 
not  subsequently  mortgaged  out  of  the  equity  in 
the  property  of  the  railroad  company  that  they  had 
at  the  time  they  were  issued. 

As  was  said,  debentures  and  notes  are  usually  put 
out  for  shorter  periods  than  secured  bonds ;  they  are 
also  usually  put  out  for  smaller  amounts  than  the 
usual  issue  of  secured  bonds,  thus  saving  the  expense 
and  trouble  of  mortgaging  the  property  of  the  road 
for  temporary  purposes.  They  are  usually  taken 
up  by  later  issues  of  refunding  or  general  mortgages 


266  RAILROAD  BONDS  AND  NOTES 

bonds.  See  Unification'  general  mortgage  bonds; 
blanket  mortgage  bonds.  Page  269.  See  also  Re- 
funding mortgage  bonds.  Page  272. 

First  lien  bonds. 

First  lien  bonds  are  secured  by  a  lien  upon  the 
mortgaged  property  that  is  prior  to  all  other  mort- 
gages or  other  liens.  They  are  secured  by  a  mort- 
gage that  is  a  first  lien  upon  the  property  it  covers. 

First  lien  bonds  are  satisfied  out  of  the  property 
covered  by  their  mortgage,  in  full,  before  any  other 
claimant  is  paid;  except  such  debts  as  are  preferred 
by  the  statutes  of  the  States,  such  as  claims  for  taxes 
and  other  governmental  charges ;  and  also  such  debts 
that  the  court  gives  a  preference  to,  such  as  claims 
for  operating  expenses  and  receivers'  certificates. 

To  be  first  lien  bonds  they  must  be  secured  by  a 
mortgage  that  is  a  first  lien  on  the  property  it  covers ; 
there  must  be  no  prior  mortgage  or  other  prior  lien, 
created  by  the  railroad  company  or  by  a  constituent 
company  before  consolidation,  against  the  property 
pledged  by  such  prior  lien  mortgage. 

A  mortgage  that  is  strictly  a  first  lien  mortgage 
usually  contains  a  representation  and  promise  by 
the  railroad  company  issuing  it  that  the  property  it 
pledges  is  subject  to  no  mortgage  or  other  lien  and 
that  it,  the  railroad  company,  will  not  create  or  suffer 
to  be  created  any  lien  that  shall  have  priority  over 
or  equality  with  the  lien  of  that  mortgage ;  and  with 


PRIORITIES  OF  THE  OTHER  CREDITORS     267 

respect  to  such  liens  as  may  be  given  a  preference, 
that  it  will  discharge  or  adequately  provide  for  them. 
Attention  may  be  here  called  to  the  fact  that  an 
issue  of  bonds  may  be  termed  "first  lien"  bonds  be- 
cause it  is  secured  by  a  first  lien  on  part  of  the  prop- 
erty that  the  mortgage  covers,  though  it  may  be  ar 
inferior  and  junior  lien  on  the  other  parts. 

First  mortgage  bonds ;  first  mortgage  trust  bonds ; 
first  mortgage  consolidated  bonds;  second, 
third,  etc.,  mortgage  bonds. 

The  term  "first  mortgage"  bonds,  as  used  in  mod- 
ern finance,  may  not  mean  that  they  are  secured  by 
a  mortgage  that  is  a  first  lien  on  all  the  property 
covered  by  the  mortgage ;  it  may  not  be  a  lien  on  the 
physical  property  of  the  issuing  company  at  all. 

The  so  called  first  mortgage  may  be  a  first  mort- 
gage or  a  first  lien  only  on  a  division  of  the  mort- 
gaged road  or  only  on  a  portion  of  the  property  it 
covers,  and  as  to  the  other  divisions  or  property  it 
covers,  it  may  be  a  lien  later,  inferior,  and  junior 
to  other  mortgages  or  other  liens  existing  against  it. 

Sometimes  a  mortgage  is  called  "first"  when  it  is 
not  a  lien  on  the  road  or  the  physical  property  of 
the  issuing  company,  but  because  such  mortgage  cov- 
ers bonds  or  other  securities  issued  by  another  rail- 
road company  and  deposited  with  the  trustee,  which 
deposited  securities  are  secured  by  a  first  mortgage 
of  some  kind  on  the  property  of  that  other  railroad 


268  RAILROAD  BONDS  AND  NOTES 

company.  When  there  is  a  default  under  the  mort- 
gage securing  the  deposited  bonds,  the  trustee  pro- 
ceeds to  foreclose  that  mortgage  and  to  realize  on- 
the  securities  that  have  been  deposited.  And  it  is 
the  duty  of  the  trustee  to  keep  under  observation 
the  company  that  issued  the  deposited  securities. 

Bonds  secured  by  securities  deposited  in  trust, 
and  which  deposited  securities  are  secured  by  a  first 
mortgage  on  the  property  of  the  company  that  issued 
them,  are  usually  called  "first  mortgage  trust"  bonds. 
See  Collateral  Trust  Bonds.  Page  277. 

In  a  further  attempt  at  analysis,  the  first  mort- 
gage consolidated  bonds  may  be  fruitful.  The  term 
"first  mortgage  consolidated"  bonds  may  be  taken  to 
mean  an  issue,  that  while  they  may  be  secured  by  a 
first  mortgage  upon  all  the  property  owned  in  the 
name  of  the  consolidated  company  that  issued  them, 
they  are  nevertheless  subject  to  such  prior  mortgages 
or  other  liens  as  the  constituent  companies,  that 
formed  the  consolidated  company,  may  have  placed 
against  such  property  before  the  consolidation  or 
merger.  When  mortgage  bonds  are  issued  by  a  con- 
solidated company  it  is  notice  to  the  intending  bond- 
holder that  they  may  be  secured  by  a  mortgage  upon 
property  that  may  have  been  derived  from  two  or 
more  constituent  companies,  and  that  they  are  there- 
fore subject  to  whatever  mortgages  or  other  liens 
that  may  have  been  placed  on  it  prior  to  the  con- 
solidation or  merger. 


PRIORITIES  OF  THE  OTHER  CREDITORS     269 

Second  mortgages,  or  third  mortgages,  or  mort- 
gages other  than  first,  are  rarely  used.  When  they 
are  used  they  are  entitled  to  priority  in  payment  out 
of  the  property  against  which  they  are  successive 
liens,  in  the  order  in  which  they  attached  to  such 
property.  See  Successive  mortgages  or  other  liens. 
Page  238.  It  seems  to  be  the  custom  when  putting 
out  an  issue  after  a  mortgage  already  exists  against 
the  property  of  the  road,  to  make  such  later  issue 
for  a  larger  sum  than  is  then  needed  and  to  secure 
it  by  a  general  mortgage  or  blanket  mortgage,  cover- 
ing all  the  property  of  the  issuing  company,  and 
with  part  of  the  proceeds  to  refund  or  to  take  up  the 
bonds  under  such  prior  mortgages  already  existing. 
In  this  way  the  bonds  of  the  later  issue  acquire  in 
time  the  standing,  rank  or  priority  that  such  first  or 
underlying  issue,  which  is  retired,  had.  See  Unifica- 
tion; general  mortgage  bonds;  blanket  mortgage 
bonds.  Page  269.  See  also  Refunding  mortgage 
bonds.  Page  272. 

Unification;    general    mortgage    bonds;    blanket 
mortgage  bonds. 

General  mortgage  bonds  or  blanket  mortgage 
bonds  are  secured  by  a  mortgage  on  all  the  property 
of  the  issuing  company.  They  invariably  follow 
some  mortgage  already  on  the  property. 

The  general  mortgage  or  blanket  mortgage  is  sub- 
ject, junior  and  inferior  to  all  the  mortgages  or 


270  RAILROAD  BONDS  AND  NOTES 

other  liens  existing  against  the  property  mortgaged 
at  the  time  it  is  executed. 

There  is  a  technical  difference  between  a  blanket 
mortgage  and  a  general  mortgage.  It  is  that  the 
blanket  mortgage,  properly  named,  covers  several 
groups  or  systems  of  the  road,  each  of  which  may 
have  no  relation  to  the  other  in  its  use;  while  a  gen- 
eral mortgage,  properly  named,  covers  one  road  or  a 
number  of  branches  or  divisions  of  the  road,  but  all 
relating  to  each  other  in  their  use.  This  distinction 
is  rarely  observed,  and  the  terms  "blanket  mortgage" 
and  "general  mortgage"  are  used  interchangeably. 
Issues  of  the  character  of  general  or  blanket  mort- 
gages are  sometimes  classified  as  unified  bonds,  as 
by  their  use  the  bonded  indebtedness  of  the  road  is 
unified;  thus  simplifying  its  handling. 

The  general  or  blanket  mortgage  is  usually  for 
an  amount  large  enough  to  meet  the  present  require- 
ments and  future  needs  of  the  road,  and  also  to 
refund  or  retire  all  or  part  of  the  bonds  secured  by 
prior  or  underlying  mortgages  or  other  liens.  And 
as  the  paying  off  or  retiring  of  the  bonds  of  the 
underlying  or  prior  mortgage  progresses,  the  lien  of 
the  blanket  or  general  mortgage  advances,  and  when 
all  the  bonds  of  the  prior  or  underlying  mortgages 
are  disposed  of,  the  general  or  blanket  mortgage 
then  occupies  the  place  that  the  mortgage  so  paid 
off  enjoyed,  which  is  usually  a  first  lien  upon  the 
property  it  covers. 


PRIORITIES  OF  THE  OTHER  CREDITORS     271 

The  blanket  or  general  mortgage  usually  provides 
for  putting  out  the  issue  in  series  or  portions.  The 
entire  amount  of  the  issue  that  has  been  authorized 
is  not  put  out  at  once.  A  certain  proportion  is  put 
out  at  the  time  of  the  execution  of  the  mortgage; 
the  next  instalment  is  put  out  at  a  fixed  time  or  upon 
the  happening  of  a  certain  event  or  contingency; 
or  instalments  in  fixed  amounts  may  be  put  out  when 
the  railroad  company,  in  its  judgment,  believes  it 
necessary;  or  the  different  series  or  instalments  may 
be  put  out  when  and  in  such  amounts  as  the  mort- 
gage may  provide.  See  Refunding  mortgage  bonds. 
Page  272. 

No  matter  when  put  out  all  the  bonds  of  the  gen- 
eral or  blanket  mortgage  are  entitled  to  the  same 
protection  of  their  mortgage,  in  the  absence  of  any- 
thing to  the  contrary  contained  in  the  mortgage. 
And  all  bonds  under  such  an  issue  are  entitled  to 
priority  over  bonds  or  other  securities  secured  by 
later  mortgages,  notwithstanding  that  the  bonds  un- 
der the  general  or  blanket  mortgage  may  have  been 
put  out  after  the  later  mortgage  was  executed.  See 
New  mortgage  before  all  bonds  or  notes  under  prior 
mortgage  are  -put  out.  Page  245. 

Underlying  liens. 

An  underlying  lien  usually  represents  the  original 
mortgage  placed  upon  the  property. 

When  a  consolidated  company  issues  its  consoli- 


272  RAILROAD  BONDS  AND  NOTES 

dated  mortgage,  it  is  subject  to  the  liens  of  those 
underlying  mortgages  that  were  placed  upon  the 
property  by  the  constituent  companies  before  con- 
solidation. See  Bonds  of  consolidated  railroads; 
bonds  of  constituent  roads.  Page  286.  See  Divi- 
sional bonds.  Page  292. 

Underlying  liens  precede  and  have  priority  over 
every  later  issue  and  are  paid  in  full  before  such 
later  mortgages  or  other  liens  receive  anything 
out  of  that  property.  Underlying  liens  are  usually 
followed,  in  time,  by  a  refunding  mortgage,  or  by 
a  blanket  or  general  mortgage  with  refunding  fea- 
tures. Part  of  the  money  raised  by  these  later  is- 
sues is  used  for  the  purpose  of  retiring  the  bonds 
secured  by  the  underlying  liens. 

In  refunding  plans,  the  underlying  issues  are  re- 
tired by  being  paid  for  with  the  proceeds  of  the 
sale  of  the  new  bonds,  or  by  exchanging  them  for 
the  new  bonds  themselves;  and  when  all  the  bonds 
secured  by  the  underlying  liens  have  been  retired, 
their  mortgage  is  canceled  and  the  new  refunding 
mortgage  succeeds  to  its  place  as  a  lien. 

Refunding  mortgage  bonds. 

Refunding  mortgage  bonds  are  those  intended  to 
retire  with  their  proceeds,  or  part  thereof,  or  by  ex- 
changing, certain  other  bonds  secured  by  prior  or 
underlying  mortgages  or  other  liens  against  the  same 
property. 


PRIORITIES  OF  THE  OTHER  CREDITORS     273 

At  the  time  it  is  executed  the  lien  of  the  mortgage 
that  secures  the  refunding  issue  is,  of  course,  inferior 
and  junior  to  that  of  the  mortgage  that  secures  the 
underlying  bonds;  but  as  the  refunding  progresses, 
the  lien  of  the  refunding  mortgage  advances,  and 
when  all  the  bonds  to  be  refunded  have  been  dis- 
posed of,  it  succeeds,  in  effect,  to  the  standing, 
priority  and  legal  rank  that  the  mortgage  that  se- 
cured the  retired  bonds  enjoyed. 

The  refunding  mortgage  is  usually  for  an  amount 
that  will  retire  the  underlying  liens,  and  that  will 
also  meet  the  present  requirements  of  the  issuing 
company  and  its  future  needs. 

The  mortgage  contains  the  plan  by  which  the 
prior  issue  shall  be  refunded. 

The  usual  refunding  plan  is  that  all  the  bonds 
of  the  new  issue  shall  be  turned  over  to  the  trustee 
under  the  terms  of  the  refunding  mortgage ;  the  trus- 
tee sells  these  new  bonds  and  with  the  proceeds  buys 
up  the  bonds  secured  by  the  underlying  liens;  or 
he  exchanges  the  new  bonds  for  them.  In  this  way, 
when  all  the  outstanding  bonds  secured  by  the  un- 
derlying liens  are  taken  up,  by  purchase  or  exchange, 
their  mortgage  is  discharged  of  record  and  the  mort- 
gage securing  the  refunding  issue  takes  its  place. 

During  the  time  that  the  refunding  goes  on,  the 
trustee,  as  he  buys  in  or  exchanges  the  old  bonds, 
holds  them  uncanceled  and  in  trust  for  his  bond- 
holders, so  that,  should  there  be  a  default  under 


274  RAILROAD  BONDS  AND  NOTES 

the  terms  of  the  underlying  mortgage,  he  will  be  in 
a  position  to  enforce  these  old  bonds  under  their 
underlying  mortgage  for  the  benefit  of  his  bondhold- 
ers of  the  new  issue. 

It  should  be  noted  that  the  lien  of  the  mortgage 
securing  the  new  issue  succeeds  to  the  lien  of  the 
mortgage  of  the  old  issue  when  the  latter  is  dis- 
charged of  record,  provided  that  between  the  time 
when  the  old  mortgage  was  recorded  and  the  time 
when  the  refunding  mortgage  was  recorded,  no  other 
lien  attached  to  the  property.  Should  a  lien  have 
attached  in  the  meantime,  it  will  take  priority  over 
the  new  refunding  mortgage.  But  this  is  a  matter 
of  form  only,  because  the  trustee  by  holding  the 
bonds  of  the  old  mortgage,  uncanceled,  is  in  a  posi- 
tion to  enforce  them  under  the  lien  of  the  old  mort- 
gage and  prior  to  the  lien  that  may  have  come  be- 
tween, should  it  be  necessary.  The  old  mortgage 
will  not  be  discharged  should  there  be  any  inter- 
vening liens  until  they  have  been  disposed  of. 

Bonds  resulting  from  consolidation,  merger,  lease 
or  control  of  property  or  stock  of  subsidiary 
companies. 

The  rapid  growth  of  our  country  has  brought 
about  railroad  consolidation.  Under  the  old  meth- 
ods when  railroad  traffic  requirements  were  small 
compared  to  those  of  to-day,  small  lines  were  oper- 
ated successfully.  They  carried  passengers  and 


PRIORITIES  OF  THE  OTHER  CREDITORS     275 

freight  between  termini  which  were  comparatively 
short  distances  apart.  In  time  arrangements  with 
connecting  lines  to  act  practically  as  extensions  be- 
came necessary.  These  connecting  or  extending 
lines  constituted  in  this  way  commercially,  though 
not  in  the  strict  legal  sense,  one  system.  Each  com- 
pany was  a  distinct  corporation;  traffic  contracts 
bound  them  commercially  together. 

The  legislatures  of  the  States  through  which  these 
roads  ran  recognized  the  advantage  and  necessity  of 
uniting  the  control  of  railroads  under  such  condi- 
tions as  existed,  and  enacted  laws  authorizing  the 
consolidation  of  connecting  or  continuous  lines. 
Then,  as  now,  these  statutes  forbade  consolidation 
of  competing  or  parallel  roads,  thus  preventing  com- 
binations between  rival  lines  that  would  stifle  healthy 
competition.  There  must  be  express  authority  for 
the  consolidation,  either  by  a  general  statute  law  or 
a  special  charter  provision. 

And  so,  in  this  way,  systems  of  railroads  were 
formed  and  later,  by  the  consolidation  or  merger  of 
these  systems,  the  gigantic  enterprises  of  to-day  were 
brought  about.  And  where  consolidation  or  merger 
was  not  permitted,  or  was  not  feasible  for  any  rea- 
son, the  control  of  branch  lines  and  of  other  rail- 
roads was  acquired  by  the  parent  company  of  a  great 
system  owning  the  property  or  a  controlling  inter- 
est in  the  capital  stock  of  such  subsidiary  company; 
or  by  lease  of  it;  or  by  the  personal  element  of  the 


276  RAILROAD  BONDS  AND  NOTES 

same  or  friendly  management;  and  in  some  instances 
through  the  means  of  the  holding  company. 

The  legislature  of  each  State  has  the  power  to 
enact  laws  that  will  affect  the  persons  and  property 
only  within  its  own  geographical  territory.  The  leg- 
islature of  one  State  has  no  power  to  create  a  cor- 
poration in  another  State.  The  legislatures  of  two 
or  more  States  cannot  combine  to  form  a  corporation. 
The  legislature  of  one  State,  however,  may  author- 
ize a  railroad  organized  under  its  laws  to  consoli- 
date with  one  of  another  State.  Should  there  be  no 
authority  for  the  consolidation  or  merger  the  same 
end  is  usually  attained  by  the  same  persons  acting  as 
officers  and  the  same  directorate  managing  all  the 
roads;  or  through  the  ownership  of  the  property  or 
controlling  interest  in  or  controlling  voting  power 
of  the  capital  stock  in  one  corporation  by  the  other. 
Their  affairs  are  then  consolidated  though  the  cor- 
porations are  not.  These  different  corporations  in 
the  different  States  may  all  use  the  same  name;  but 
each  exists  as  a  separate  corporation.  By  any  of 
these  methods  the  policies  of  two  or  more  railroads 
may  be  kept  in  harmony  and  serve  each  other's 
needs ;  and  a  system  is  thus  formed. 

The  plan  for  controlling  a  railroad  through  the 
ownership  of  a  controlling  interest  in  its  capital  stock 
has  developed  the  holding  company.  This  is  a  sep- 
arate corporation  whose  only  purpose  seems  to  be 
to  hold  controlling  amounts  or  interests  in  the  cap- 


PRIORITIES  OF  THE  OTHER  CREDITORS     277 

ital  stocks  of  the  various  companies  that  form  the 
system.  It  does  not  operate  any  road;  but  it  man- 
ages all  of  them.  It  has  a  controlling  vote  in  each 
corporation  of  the  system,  therefore,  elects  their  re- 
spective boards  of  directors,  decides  the  policies  of 
each  and  by  this  consolidation  of  power,  controls 
and  is  absolute  master  of  the  entire  system.  These 
holding  companies  are  not  favored  in  law  when  they 
tend  to  stifle  competition.  Recent  legislation  has 
been  directed  against  them. 

From  the  financing  of  these  enterprises  and  the 
consolidation,  merger,  lease  or  control  of  the  differ- 
ent railroads,  there  have  resulted  securities  such  as 
collateral  trust  bonds,  consolidated  bonds,  underly- 
ing bonds  of  constituent  companies,  divisional  bonds, 
guaranteed  bonds,  bonds  of  leased  lines,  assumed 
bonds,  endorsed  bonds,  stamped  bonds,  terminal 
bonds,  etc.  To  a  consideration  of  the  rights  and 
remedies  under  these  various  forms  of  securities  and 
their  respective  priorities,  the  following  pages  are 
directed. 

Collateral  trust  bonds;  collateral  trust  notes;  con- 
vertible collateral  trust  bonds  or  notes ;  partici- 
pating or  profit  sharing  bonds;  three  methods 
of  issuing  collateral  trust  bonds. 

Collateral  trust  bonds  or  notes  are  those  secured 
by  a  mortgage  under  which  the  issuing  company 
pledges  securities  belonging  to  it,  such  as  stocks  and 


278  RAILROAD  BONDS  AND  NOTES 

bonds,  from  its  own  treasury,  or  the  securities  issued 
by  some  subsidiary  company  that  it  controls.  The 
physical  property  of  its  road  is  not  mortgaged. 

Collateral  trust  bonds  or  notes  are  usually  issued 
by  the  parent  company  of  a  system  depositing  with 
the  trustee  under  its  mortgage  the  stocks  or  bonds, 
or  both,  of  the  minor  or  subsidiary  road  or  roads  it 
controls. 

Under  the  collateral  trust  mortgage  the  securities 
that  are  pledged  are  deposited  with  the  trustee. 

When  the  deposit  consists  of  different  kinds  of 
securities,  such  as  railroad  bonds,  municipal  bonds, 
stocks,  etc.,  it  is  called  "mixed  collateral." 

Should  first  mortgage  bonds  be  deposited  the  is- 
sue is  sometimes  called  "first  mortgage  collateral 
trust  bonds."  See  First  mortgage  bonds;  first  mort- 
gage trust  bonds.  Page  267. 

Notes  secured  by  a  collateral  trust  mortgage  are 
sometimes  referred  to  as  "mortgage  trust  notes,"  be- 
sides the  more  common  designation  of  collateral  trust 
notes. 

Collateral  trust  mortgages  may  provide  that  the 
securities  deposited  with  the  trustee  may  be  with- 
drawn, from  time  to  time,  by  the  railroad  company 
issuing  the  mortgage,  and  others  substituted  in  their 
stead.  Such  substitution  can  be  made  only  on  the 
consent  of  the  trustee  and  under  his  supervision. 

The  power  is  sometimes  conferred  on  the  trustee 
by  the  mortgage  to  demand  that  the  railroad  com- 


PRIORITIES  OF  THE  OTHER  CREDITORS      279 

pany  shall  substitute  new  securities  for  such  as,  in 
his  opinion,  shall  have  diminished  in  value  and  are 
no  longer  an  adequate  security.  The  railroad  com- 
pany must  comply  with  such  demand  within  the 
time  limited  in  the  mortgage,  and  a  failure  to  do  so 
will  be  a  default. 

Where  the  mortgage  provides  for  the  substitution, 
converting,  or  changing  of  the  securities,  the  issue 
is  usually  called  "convertible  collateral  trust  bonds." 

The  income  from  the  pledged  securities  is  also  pro- 
vided for  in  the  mortgage.  Usually  the  trustee  re- 
ceives it  and  pays  the  interest  on  the  collateral  trust 
bonds  and  with  the  surplus,  if  any,  he  maintains  a 
sinking  fund.  The  terms  of  the  issue  may  be  that 
the  railroad  company  making  the  issue  shall  pay  the 
interest  on  the  collateral  trust  bonds  directly,  and 
accordingly  shall  receive  the  dividends  and  interest 
on  the  deposited  securities. 

The  rate  of  interest  payable  on  collateral  trust 
bonds  is  usually  at  a  fixed  rate;  however,  it  may  be 
arranged  in  the  mortgage  that  the  rate  of  interest, 
while  specified  at  a  certain  percentum,  may  be  in- 
creased. 

A  provision  of  this  kind  is  usually  to  the  effect 
that  should  the  deposited  stock  pay  a  dividend  or 
dividends  beyond  a  certain  amount,  the  rate  of  in- 
terest on  the  collateral  trust  bonds  shall  be  increased 
proportionately.  When  the  mortgage  contains  such 
arrangement,  the  issue  is  known  as  collateral  trust 


28o  RAILROAD  BONDS  AND  NOTES 

bonds  with  the  participating  or  profit  sharing  fea- 
ture. This  feature,  however,  is  rarely  employed. 

Collateral  trust  bonds  are  usually  issued  for 
shorter  periods  than  the  usual  form  of  railroad  bonds, 
as  they  are  issued  at  times  when  the  interest  rate  is 
unfavorable  to  the  road,  or  at  a  time  when  the  con- 
dition of  the  market  or  of  the  credit  of  the  issuing 
company  may  adversely  influence  their  price.  It  is 
therefore  to  avoid  the  encumbering  of  the  property 
of  the  road  with  a  mortgage  to  secure  an  issue  of 
bonds  for  a  long  period,  put  out  at  a  higher  rate  of 
interest  and  at  a  lower  price  than  would  probably 
prevail  in  the  near  future,  that  collateral  trust  bonds 
or  notes  are  sometimes  issued.  When  conditions  are 
more  favorable  an  issue  with  a  refunding  feature 
may  be  put  out  and  the  collateral  trust  bonds  or 
notes  taken  up. 

Accordingly,  the  railroad  company  in  issuing  the 
collateral  trust  bonds  or  notes  usually  reserves  the 
right  to  pay  them  off,  in  full  or  in  part,  before  ma- 
turity. This,  together  with  the  privilege  of  con- 
verting or  changing  the  deposited  securities,  gives 
the  railroad  company  an  opportunity  to  take  ad- 
vantage of  the  market  and  to  dispose  of  any  or  all 
of  the  deposited  securities  that  may  be  selling  at  a 
good  price  and  with  the  proceeds  pay  off  the  col- 
lateral trust  bonds  which  are  usually  issued  at  a 
higher  rate  of  interest  than  other  mortgage  bonds. 

The  mortgage  securing  the  collateral  trust  bonds 


PRIORITIES  OF  THE  OTHER  CREDITORS      281 

usually  provides  that  the  issuing  railroad  company 
shall  not  place  upon  the  property  of  the  subsidiary 
company,  whose  stocks  and  bonds  are  deposited  un- 
der the  mortgage,  nor  suffer  to  be  placed  thereon, 
any  mortgage  or  other  lien  that  will  interfere  with 
or  prejudice,  in  any  way,  the  rights  and  remedies 
of  the  holders  of  the  collateral  trust  bonds. 

The  collateral  trust  mortgage  creates  no  lien  on 
the  tangible  property  constituting  the  "road"  of  the 
issuing  company,  such  as  its  real  estate,  rolling  stock, 
and  other  property  of  kindred  nature.  In  this  it 
differs  from  the  usual  railroad  mortgage  which  does 
create  a  direct  lien  on  the  tangible  property  of  the 
issuing  railroad  company  mentioned  in  the  mort- 
gage- 

The  collateral  trust  mortgage  creates  only  an  in- 
direct lien  on  the  property  of  the  company  whose 
securities  are  deposited,  in  that  the  lien  of  the  col- 
lateral trust  mortgage  is  upon  the  deposited  securi- 
ties only,  though  they,  in  turn,  under  their  mortgage, 
are  a  direct  lien  (if  mortgage  bonds  be  deposited) 
upon  the  tangible  property  of  the  railroad  company 
that  issued  them. 

In  order  to  realize  on  the  collateral  trust  mortgage, 
its  trustee,  upon  default  of  the  issuing  company, 
forecloses  his  mortgage  against  the  deposited  stocks 
and  bonds  or  otherwise  realizes  upon  them  under 
any  other  remedies  that  the  mortgage  may  give  him, 
among  them,  selling  them  in  the  market. 


282  RAILROAD  BONDS  AND  NOTES 

The  foreclosure  of  a  collateral  trust  mortgage  is 
more  involved  than  that  of  the  ordinary  mortgage. 
The  decree  of  foreclosure  covers  only  the  stocks  and 
bonds  pledged,  and  they  pass  to  the  trustee,  under 
the  decree,  to  be  realized  upon  by  him.  He  may 
sell  them,  if  the  court  believes  this  advisable;  or 
the  court  may  declare  that  the  trustee  shall  be  re- 
garded as  the  holder  of  such  stocks  and  bonds  and 
shall  proceed  against  the  property  of  the  subsidiary 
company  that  issued  such  deposited  securities,  upon 
its  default  under  its  mortgage.  The  affairs  of  the 
subsidiary  company  and  those  of  the  parent  company 
are  usually  so  interlocked  that  the  insolvency  of  the 
latter  affects  the  former,  and  where  the  parent  com- 
pany is  in  difficulties  and  has  defaulted,  it  will  be 
found  invariably  that  a  like  condition  exists  with 
regard  to  the  subsidiary  company. 

And  when  the  parent  company  has  defaulted  on 
its  collateral  trust  bonds,  the  subsidiary  company 
will  be  found  to  have  defaulted  on  its  securities  that 
have  been  deposited.  The  trustee  is  then  in  a  posi- 
tion to  proceed  against  such  deposited  securities  and 
in  that  way  get  at  the  physical  property  that  was 
mortgaged  to  secure  the  deposited  bonds  of  the 
subsidiary  company;  and  where  its  stock  has  been 
deposited,  to  realize  on  the  rights  in  its  property, 
mortgaged  or  unencumbered,  that  such  stock  repre- 
sents. To  avoid  the  expense  and  delay  that  attends 
these  separate  foreclosures,  the  trustee  is  usually  em- 


PRIORITIES  OF  THE  OTHER  CREDITORS      283 

powered  by  the  mortgage  to  enter  into  possession  of 
the  property  that  was  mortgaged  to  secure  the  de- 
posited bonds  and  sell  the  same. 

While  railroad  companies  may  issue  collateral 
trust  bonds  or  notes  and  secure  them  by  a  mortgage 
against  stocks  and  bonds  which  it  deposits  with  the 
trustee,  taking  such  stocks  and  bonds  from  its  own 
treasury,  this  form  of  bond  and  mortgage  is  more 
commonly  used  to  raise  money  to  build  an  extension 
or  branch  line  which  is  or  will  become  a  subsidiary 
company. 

The  new  division,  extension,  or  branch  line,  by 
whatever  name  it  may  be  referred  to,  is  always  in- 
corporated as  a  separate  and  distinct  legal  body. 

There  are  three  methods  of  financing  employed 
when  raising  funds  for  the  subsidiary  company,  in 
which  the  collateral  trust  bond  and  mortgage  is 
used. 

(i)  The  parent  company  may  supply  the  neces- 
sary money  to  the  subsidiary  company  for  the  con- 
struction of  the  extension  or  branch,  by  buying  its 
capital  stock  and  its  bonds  which  it  issues,  or  a  con- 
trolling interest  in  them.  The  parent  company  then 
reimburses  itself  by  selling  its  own  issue  of  collateral 
trust  bonds,  its  own  direct  obligation,  securing  them 
by  depositing  the  stocks  and  bonds  of  the  newly  in- 
corporated branch  line,  which  it  has  purchased.  In 
this  case  the  parent  company  pays  cash  for  the  stock 
and  bonds  of  the  subsidiary  company  and  then  reim- 


284  RAILROAD  BONDS  AND  NOTES 

burses  itself  by  the  sale  of  its  own  collateral  trust 
bonds.  This  method  means  the  withdrawal  from 
the  treasury  of  the  parent  company  of  a  large  sum  of 
money  which  may  embarrass,  even  though  tempora- 
rily, its  own  affairs. 

(2)  Plans  whereby  the  actual  outlay  of  money 
from  the  treasury  of  the  parent  company  is  avoided, 
are  more  favored. 

By  these  latter  plans,  the  parent  company  issues 
its  collateral  trust  bonds,  its  own  direct  obligation, 
and  exchanges  them  for  the  stocks  and  bonds  of  the 
subsidiary  company.  After  the  exchange  is  made, 
it  then  deposits  these  stocks  and  bonds  of  the  sub- 
sidiary company,  in  trust  with  the  trustee  under  its 
collateral  trust  mortgage,  as  security  for  its  own  col- 
lateral trust  bonds,  which  it  has  given  the  subsidiary 
company  in  exchange  for  the  stocks  and  bonds  of  the 
latter.  The  parent  company,  in  this  instance,  does 
not  pay  out  in  cash;  it  merely  exchanges  its  collat- 
eral trust  bonds  for  the  stocks  and  bonds  of  the  sub- 
sidiary company,  and  when  the  latter  are  received 
they  are  deposited  as  security  for  the  collateral  trust 
bonds  of  the  parent  company.  The  subsidiary  com- 
pany then  sells  these  collateral  trust  bonds,  the  obli- 
gation of  the  parent  company,  and  with  the  proceeds 
builds  the  extension  or  branch.  By  this  method  the 
parent  company  only  pays  interest  on  its  issue  of 
collateral  trust  bonds  and  awaits  the  time  when  the 
subsidiary  company  road  will  be  built  and  earning 


PRIORITIES  OF  THE  OTHER  CREDITORS      285 

income  to  pay  the  interest  on  its  bonds  and  dividends 
on  its  capital  stock. 

(3)  The  other  plan  by  which  the  parent  company 
avoids  an  actual  outlay  is  that  whereby  it  issues 
its  collateral  trust  bonds,  secured  by  a  mortgage,  and 
sells  them  on  the  market.  By  the  terms  of  this  mort- 
gage, the  trustee  receives  the  proceeds  from  the  sale 
of  the  collateral  trust  bonds  and  with  it  immediately 
purchases  an  equal  amount  in  value,  as  regulated  in 
the  mortgage,  of  the  bonds  and  the  stock  of  the 
subsidiary  company.  He  then  holds  these  stocks 
and  bonds  so  purchased  as  security  under  the  collat- 
eral trust  mortgage.  In  this  case,  the  transaction  is, 
in  effect,  similar  to  the  last  method,  except  that  the 
collateral  trust  bonds  are  sold  by  the  parent  company 
instead  of  by  the  subsidiary  company. 

In  neither  of  the  last  two  cases  does  the  parent 
company  advance  the  money;  it  merely  pays  the 
interest  on  the  collateral  trust  bonds,  until  the  branch 
line  is  built  and  earns  income  and  can  pay  interest 
on  its  bonds  and  dividends  on  its  stock.  This  is  its 
only  outlay  of  money.  When  the  subsidiary  com- 
pany pays  such  interest  and  dividends,  they  will  at 
least  be  sufficient  to  pay  the  interest  on  the  collateral 
trust  bonds  and  thus  relieve  the  parent  company  from 
further  outlay. 

As  a  security  the  collateral  trust  bond  is  said  to 
commend  itself,  as  it  is  the  direct  obligation  of  the 
parent  company,  usually  of  a  large  system,  and  is 


286  RAILROAD  BONDS  AND  NOTES 

quite  generally  secured  by  a  first  lien  upon  some  spe- 
cific piece  of  property  or  division  of  the  system,  in- 
stead of  being  secured,  as  is  the  ordinary  railroad 
mortgage  bond,  upon  an  entire  system  subject  to  a 
number  of  prior  liens  and  mortgages.  The  question 
of  the  value  of  the  property  covered  by  the  deposited 
mortgage  and  represented  by  the  deposited  stock, 
of  course,  enters  largely  into  consideration. 

Bonds  of  consolidated  railroads;  bonds  of  the  con- 
stituent roads. 

The  term  "consolidated  bonds"  is  used  to  desig- 
nate those  issued  by  a  railroad  company  that  has 
been  formed  by  the  consolidation  of  two  or  more 
railroad  companies,  theretofore  existing  as  separate 
corporations.  Each  company  that  was  consolidated 
or  merged  is  called  a  "constituent"  company. 

The  effect  of  consolidation  or  merger  of  two  or 
more  railroads  is  to  extinguish  the  original  or  con- 
stituent companies  and,  by  combining  them,  form  a 
new  company.  Though  for  the  purpose  of  contin- 
uing their  obligations,  each  constituent  company  is 
presumed,  in  theory,  to  continue. 

This  new  company,  under  the  agreement  for  the 
consolidation,  or  under  the  statutes  pursuant  to 
which  the  consolidation  was  carried  out,  acquires  all 
the  property  of  the  constituent  companies,  and  must 
meet  and  pay  all  the  debts  and  other  obligations  of 
such  constituent  companies. 


PRIORITIES  OF  THE  OTHER  CREDITORS      287 

The  term  "consolidated"  bonds  is  also  employed 
sometimes  to  designate  an  issue  by  a  railroad  com- 
pany to  raise  money  to  build  a  branch  or  extension, 
and  secured  by  a  mortgage  on  this  branch  or  exten- 
sion and  also  on  the  main  line.  In  such  case,  as  to 
the  branch  or  extension,  this  mortgage  is  a  first  mort- 
gage, and  as  to  the  main  line,  it  takes  its  place  be- 
hind whatever  mortgages  may  already  exist  against 
that  property.  An  issue  of  this  kind,  when  a  first 
mortgage  on  the  extension,  and  no  matter  what  its 
standing  as  a  lien  on  the  property  of  the  main  line, 
is  usually  called  "first  consolidated  mortgage"  bonds. 

The  consolidated  bond,  issued  by  a  consolidated 
company,  is  usually  secured  by  a  mortgage  issued  by 
such  consolidated  company,  which  creates  a  lien  on 
its  property.  That  is,  the  mortgage  is  on  the  prop- 
erty owned  by  the  consolidated  company  at  the  time 
the  mortgage  was  executed.  It  should  always  be 
borne  in  mind  that  any  mortgages  or  other  liens  that 
the  consolidated  company  may  create  against  its 
property  is  always  subject,  inferior  and  junior  to 
those  mortgages  or  other  liens  that  existed  against 
that  property  at  the  time  of  the  consolidation  or 
merger.  In  other  words,  the  consolidated  company 
takes  the  property  from  its  constituent  companies  in 
the  condition  it  was  in  at  the  time  of  the  consolida- 
tion or  merger;  and  if  the  constituent  company  had, 
prior  to  that  time,  placed  any  mortgage  or  other  lien 
against  it,  the  property  passes  into  the  possession 


288  RAILROAD  BONDS  AND  NOTES 

of  the  consolidated  company  with  these  mortgages 
or  other  liens  continuing  in  full  force;  and  when 
this  property  is  sold,  it  must  first  satisfy,  in  full,  such 
mortgages  or  other  liens  that  the  constituent  com- 
panies may  have  placed  against  it  prior  to  the  con- 
solidation or  merger,  before  the  holders  of  the  bonds 
issued  after  the  consolidation  or  merger,  by  the  con- 
solidated company,  receive  anything. 

The  mortgages  or  other  liens  placed  on  the  prop- 
erty by  the  constituent  companies  before  consolida- 
tion are  referred  to  as  underlying  liens.  See  Under- 
lying liens.  Page  271. 

The  mortgages  that  the  consolidated  company 
gives  have  priority  over  the  unsecured  creditors  of 
the  constituent  companies,  in  payment  out  of  the 
property  covered  by  such  mortgages. 

The  distinction  between  the  consolidation  and  the 
reorganization  of  a  railroad  is  so  generally  known, 
that  to  point  out  the  salient  differences  here  may 
seem  a  superfluous  statement  of  elementary  princi- 
ples. In  both  cases  a  new  corporation  succeeds  the 
old  one.  The  reorganization  of  a  railroad  may  be 
perfected  among  its  stockholders,  its  bondholders  or 
other  creditors,  without  any  court  proceedings; 
though  a  road  is  usually  reorganized  after  fore- 
closure of  a  defaulted  mortgage.  There  is  then 
usually  some  difficulty  or  embarrassment,  financial 
or  otherwise.  The  consolidation  of  railroads  is  not 
the  result  of  any  judicial  or  court  proceedings,  nor 


PRIORITIES  OF  THE  OTHER  CREDITORS      289 

the  result  of  any  financial  or  other  embarrassment 
of  the  road,  but  is  carried  out  by  an  agreement, 
authorized  by  the  statutes  of  the  States,  between 
two  or  more  railroad  corporations,  after  the  proper 
consents  of  their  respective  stockholders  have  been 
obtained.  In  this  agreement,  provision  is  made 
usually  for  the  distribution  of  the  intended  stock 
of  the  new  corporation,  for  its  taking  over  the  prop- 
erty of  the  constituent  companies,  and  for  its  assum- 
ing the  bonds  and  other  debts  and  obligations  of  the 
constituent  companies. 

The  holders  of  the  bonds  of  the  constituent  com- 
panies have  no  voice  in  whether  or  not  their  com- 
pany, upon  whose  property  they  have  a  mortgage, 
shall  consolidate.  They  are  not  affected  for  that 
company  can  do  nothing,  in  this  respect,  that  will 
prejudice  the  lien  of  the  mortgage  against  its  prop- 
erty securing  these  outstanding  bonds.  Such  mort- 
gaged property  is  taken  over  by  the  consolidated 
company  with  the  lien  of  all  the  mortgages  against 
it  continuing  in  full  force.  And,  as  was  seen,  any 
mortgage  or  other  lien  that  the  consolidated  com- 
pany may  attempt  to  charge  against  this  property 
must  be  inferior  and  junior  to  and  is  paid  out  of 
that  property  after  the  claims  of  bondholders  un- 
der the  mortgages  of  the  constituent  companies  be- 
fore consolidation  have  been  paid  in  full. 

The  rights  and  remedies  of  holders  of  the  bonds 
of  the  constituent  companies  cannot  be  taken  from 


290  RAILROAD  BONDS  AND  NOTES 

them  by  this  agreement  between  the  railroad  com- 
pany and  others  to  which  they  are  not  parties  and 
have  not  consented. 

Where  no  other  arrangement  is  made  the  consoli- 
dated company  is  answerable  for  the  debts  and  lia- 
bilities of  each  constituent  company  to  the  extent 
of  the  property  acquired  from  it,  though  it  usually 
assumes  full  liability  for  such  debts  and  obligations 
without  any  limitation.  However,  any  mortgage 
that  the  consolidated  company  may  give  on  the  prop- 
erty it  acquires  by  the  consolidation  from  the  con- 
stituent company,  though  it  is  subject  to  all  mort- 
gages already  existing  against  it,  is  entitled  to 
priority  over  the  unsecured  debts  of  that  constituent 
company. 

The  consolidated  company  having  thus  acquired 
the  franchises  of  the  constituent  companies  must 
assume  and  perform  all  the  public  duties  which  were 
imposed  upon  the  latter  by  their  respective  charters 
and  franchises. 

The  holders  of  the  bonds  of  the  constituent  com- 
panies, however,  cannot  arbitrarily  be  compelled  to 
accept  the  liability  of  the  consolidated  company  in 
place  of  that  of  their  original  issuing  company. 
The  holder  of  the  mortgage  bonds  of  railroad  com- 
panies is  presumed,  in  law,  to  have  in  view  at  the 
time  of  his  purchase  that  the  company  has  the 
power  to  consolidate  with  another  or  other  railroad 
companies.  He  takes  his  bond  and  mortgage  sub- 


PRIORITIES  OF  THE  OTHER  CREDITORS      291 

ject  to  such  public  laws,  as  may  exist  at  the  time, 
authorizing  railroad  companies  to  consolidate,  and 
he  is  bound  by  any  provision  they  may  make  with 
respect  to  his  right  to  convert  his  bond  into  the 
capital  stock  of  the  constituent  company  or  the  con- 
solidated company. 

He  will  not  be  deprived  of  his  right  to  con- 
vert his  bonds  into  capital  stock  by  the  consolida- 
tion or  merger  of  the  company  issuing  his  bonds, 
though  such  rights  may  be  regulated  by  the  statutes 
permitting  such  consolidation.  Holders  of  railroad 
bonds  are  bound  by  all  laws  regulating  consolida- 
tions or  mergers.  Such  regulations  are  usually  to 
the  effect  that  the  bondholders  with  such  privilege 
of  conversion  must  demand  their  stock  in  the  con- 
stituent company  within  a  designated  period.  They 
must  have  a  fair  opportunity  to  do  so. 

Should  they  not  demand  their  stock  within  the 
time  the  statute  limits  them  to,  they  are  presumed 
to  have  assented  to  the  plan  and  agreement  of  con- 
solidation and  the  provisions  therein  made  for 
them.  These  provisions  are  usually  that  the  hold- 
ers of  the  bonds  of  the  constituent  companies,  hav- 
ing the  privilege  of  conversion,  shall  be  entitled  to 
receive  stock  in  the  consolidated  company,  instead 
of  in  the  constituent  company,  should  they  choose  it 
or  should  they  not  exercise  their  right  to  demand 
stock  of  the  constituent  company  within  the  time 
or  in  the  manner  regulated  by  the  statute. 


292  RAILROAD  BONDS  AND  NOTES 

Should  the  statutes  or  agreement,  under  which  the 
consolidation  was  carried  out,  make  no  provision  for 
conversion  by  the  holders  of  the  bonds  of  the  con- 
stituent companies  into  their  capital  stock,  and  should 
the  consolidated  company  have  assumed  the  obliga- 
tions of  the  constituent  companies,  then  such  bond- 
holders are  entitled  to  demand  and  receive  stock  of 
the  consolidated  company. 

Divisional  bonds. 

As  the  name  suggests,  divisional  bonds  are  those 
secured  by  a  mortgage  on  a  division  only  of  a 
system. 

They  are  sometimes  issued  by  a  subsidiary  com- 
pany and  secured  by  a  mortgage  on  its  property, 
which  is  a  branch  or  division  of  the  parent  company 
or  main  road.  The  parent  company  sometimes 
guarantees  the  bonds  of  its  subsidiary  companies. 

The  security  in  the  case  of  the  divisional  bond  is 
limited  to  that  covered  by  the  mortgage  which  covers 
only  that  branch  or  division.  Such  divisional  bonds 
are  not  the  direct  obligation  of  the  parent  company. 
Should  there  be  no  guarantee,  the  parent  company  is 
in  no  way  liable  on  these  bonds;  should  there  be  a 
guarantee  the  liability  of  the  parent  company  is  lim- 
ited to  the  terms  of  the  guaranty.  See  Guaranteed 
bonds.  Page  293. 

Divisional  bonds,  sometimes,  are  the  direct  obli- 


PRIORITIES  OF  THE  OTHER  CREDITORS     293 

gations  of  the  parent  company  but  secured  only  by 
a  mortgage  on  a  division.  As  to  the  other  parts  or 
divisions  of  the  system  which  the  mortgage  does  not 
cover,  the  holders  of  these  divisional  bonds  have  no 
recourse  until  all  the  mortgages  and  other  liens 
thereon  have  been  satisfied  in  full. 

The  name  "divisional  bonds"  is  also  sometimes 
given  to  the  issue  of  a  railroad  that  has  subsequently 
consolidated.  It  is  really  the  bond  of  one  of  the 
constituent  companies  that  formerly  operated  a  road 
that  is  now  a  branch  or  a  division  of  the  parent  or 
main  company,  such  issue  having  been  secured  by  a 
mortgage  on  such  branch  or  division  executed  by  the 
constituent  company  before  consolidation.  Such  di- 
visional bonds  are  entitled  to  be  paid  in  full  out 
of  the  division  covered  by  their  mortgage  before  any 
of  the  issues,  secured  by  mortgage  on  the  same  prop- 
erty subsequently  put  out  by  the  consolidated  com- 
pany, receive  anything  from  that  division. 

Guaranteed  bonds. 

Guaranteed  bonds  are  issued  by  one  railroad  com- 
pany and  guaranteed  by  another. 

The  contract  of  guaranty  is  usually  a  printed  or 
written  form  executed  by  the  guaranteeing  company 
whereby,  for  value  received,  it  guarantees  the  pay- 
ment of  the  principal  or  the  interest  of  the  bonds,  or 
both,  as  the  case  may  be,  at  the  time  and  place  where 


294  RAILROAD  BONDS  AND  NOTES 

they  are  payable.  The  guaranty  may  be  endorsed 
upon  each  bond  or  by  one  separate  contract  include 
the  entire  issue. 

When  the  issue  of  bonds  is  guaranteed  before  it 
is  put  out,  the  guaranty  is  endorsed  upon  each  bond 
and  the  bonds  are  usually  known  as  "guaranteed  by 
endorsement."  If  the  guaranty  is  given  after  the 
issue,  or  part  of  it,  has  been  put  out  then,  of  course, 
the  guaranty  cannot  be  endorsed  upon  each  bond 
already  out,  nor  would  it  be  practicable  to  recall 
the  bonds  to  have  them  so  endorsed.  The  guaranty 
is  then  made  by  a  separate  contract.  The  effect, 
however,  is  the  same.  As  to  those  bonds  that  have 
not  been  put  out  at  the  time  the  guaranty  is  made, 
it  may  be  endorsed  on  them  or  they  may  also  be  in- 
cluded in  the  separate  contract  of  guaranty. 

The  guaranty  may  be  to  the  bondholders  direct 
or  to  the  trustee  in  their  behalf. 

The  contract  of  guaranty  is  a  contract  independent 
of  the  obligation  of  the  issuing  company.  It  may 
be  so  far  an  independent  obligation  of  the  guarantee- 
ing company  that  it  may  be  liable  on  its  guaranty 
even  though  the  bonds  it  guarantees  are  void. 

The  guaranty  of  the  bonds,  no  matter  in  which 
form  it  may  be,  is  an  incident  to  such  bonds  and 
passes  into  the  hands  of  whomsoever  such  bonds  may 
come.  Each  successive  holder  of  the  guaranteed 
bonds  is  entitled  to  enforce  the  guaranty  while  he 
holds  it. 


PRIORITIES  OF  THE  OTHER  CREDITORS     295 

Guaranties  vary  in  their  terms  according  to  the 
objects  to  be  attained  and  the  circumstances  attend- 
ing the  giving  of  the  guaranty.  Therefore,  just 
what  the  guaranteeing  company  undertakes  to  do 
should  be  fully  understood.  It  cannot  be  held  be- 
yond the  strict  terms  of  its  guaranty.  If  its  liability 
depends  upon  any  conditions,  these  conditions  should 
be  fully  understood.  No  doubt  or  ambiguity  should 
exist  as  to  just  what  the  guaranty  is.  In  a  full 
guaranty,  the  guaranteeing  company's  liability 
should  be  commensurate  with  that  of  the  issuing  com- 
pany. That  is,  the  guaranteeing  company  should  be 
liable  to  do  and  to  pay  all  that  the  issuing  company 
should;  and  the  liability  of  the  guaranteeing  com- 
pany should  become  fixed  immediately  upon  the  de- 
fault of  the  issuing  company,  without  any  pre- 
liminaries of  any  kind. 

The  situations  and  reasons  that  bring  about  a 
guaranty  of  railroad  bonds  are  many  and  varied. 
The  one  most  common  is  that  of  a  parent  company, 
the  main  company  of  a  system,  guaranteeing  the 
bonds  issued  by  one  of  its  constituent  or  subsidiary 
companies  or  issued  by  a  road  that  it  controls  by 
lease  or  otherwise. 

The  guaranteeing  of  railroad  bonds  also  results 
from  the  plan  for  the  reorganization  or  readjustment 
of  the  affairs  of  a  road.  The  bondholders  of  the 
old  company  find  often  that  it  is  to  their  best  inter- 
ests to  help  along  the  reorganization  or  readjustment 


296  RAILROAD  BONDS  AND  NOTES 

by  making  concessions.  At  such  a  time  they  may 
accept  bonds  for  a  less  amount,  or  for  a  lower  rate 
of  interest,  in  exchange  for  their  own.  They  are 
often  induced  to  do  so  by  the  guaranty  of  the  inter- 
est or  the  principal,  or  both,  of  their  bonds. 

Guaranteed  bonds  result  also  from  the  use  in 
common  of  stations,  bridges,  terminals  or  other 
property  by  two  or  more  railroad  companies.  One 
or  more  of  these  companies  will  guarantee  the  bonds 
of  the  company  that  owns  the  property  so  used  in 
common.  The  bonds  so  guaranteed  are  usually 
secured  by  a  mortgage  only  on  this  property  so  used 
in  common,  though  the  mortgage  may  be  on  other 
property  of  the  issuing  company. 

The  after  acquired  property  clause  in  railroad 
mortgages  may  sometimes  result  in  a  guaranty  of  an 
issue  of  bonds.  The  parent  company  which  has 
already  issued  and  has  outstanding  its  mortgage  con- 
taining an  after  acquired  property  clause,  may  want 
to  acquire  another  branch  or  division  or  extension. 
This  newly  acquired  property  may  fall  within  the 
mortgage,  under  the  clause  mentioned;  therefore,  to 
keep  it  from  the  inclusion  of  that  after  acquired 
property  clause,  the  property  is  taken  in  the  name  of 
a  corporation  purposely  organized  to  hold  it.  An 
issue  of  bonds  is  put  out  by  that  new  corporation, 
secured  by  a  mortgage  on  this  newly  acquired  branch, 
division  or  extension,  and  guaranteed  by  the  parent 
company. 


PRIORITIES  OF  THE  OTHER  CREDITORS     297 

Sometimes  this  device  of  holding  the  property  in 
the  name  of  a  separate  company  is  necessary  where 
the  mortgages  of  the  parent  company  already  exist- 
ing, have  reached  the  limitation  of  indebtedness 
fixed  by  the  laws  of  the  State  in  which  it  was  in- 
corporated; or  where  under  the  laws  of  the  State  in 
which  the  new  division  or  other  newly  acquired 
property  is  situated,  it  is  necessary  that  a  resident 
corporation  shall  own  it. 

The  railroad  company  formed  by  consolidation  or 
merger  may  guarantee  the  bonds  its  constituent  com- 
panies issued  before  such  consolidation  or  merger. 

The  guaranty  may  be  of  the  interest  or  of  the 
principal,  or  both. 

The  guaranty  of  interest  may  or  may  not  run  for 
the  entire  term  of  the  bonds. 

When  interest  is  guaranteed,  in  some  instances, 
it  is  done  for  a  limited  period  only.  This  is  when 
a  comparatively  new  company  issues  its  bonds  at  a 
time  when  the  public  may  not  have  confidence  in  its 
ability  to  earn  the  interest  on  its  bonded  indebted- 
ness during  the  period  that  it  is  establishing  itself. 
Under  such  circumstances,  the  interest  is  guaranteed 
for  such  time  as  will  carry  it  over  the  period  of 
development  and  growth.  Then  the  inquiry  in- 
trudes: Are  the  possibilities  of  the  road  such  as  to 
develop  sufficient  strength  to  meet  payments  of  in- 
terest beyond  that  period  and  of  the  principal  when 
due? 


298  RAILROAD  BONDS  AND  NOTES 

Should  principal  only  be  guaranteed,  and  the 
bonds  are  for  a  long  time,  the  intending  bondholder 
should  consider  that  in  the  meantime  much  may 
happen  with  regard  to  the  relation  between  the  sub- 
sidiary company  and  the  guaranteeing  company,  and 
the  standing  of  the  latter. 

Upon  a  reorganization  of  the  guaranteeing  com- 
pany its  relation  to  the  subsidiary  company,  whose 
bonds  it  has  guaranteed,  and  which  it  has  operated 
under  a  lease,  is  usually  changed.  The  lease  will 
then  probably  be  readjusted  in  some  way.  It  may 
be  dropped  entirely  or  changed  to  meet  new  con- 
ditions. 

The  leased  road  sometimes  requires  security  from 
the  leasing  company  that  the  latter  will  perform  all 
the  obligations  imposed  upon  it  by  the  lease;  and, 
accordingly,  securities  are  deposited  in  trust,  to  be 
forfeited  upon  a  breach  of  the  lease.  This,  of 
course,  adds  to  the  guaranty  and  makes  the  lease 
something  not  to  be  lightly  discarded. 

The  holders  of  guaranteed  bonds  are  not  creditors 
of  the  guaranteeing  company  until  the  latter  has 
become  actually  liable.  That  is,  there  must  have 
been  a  default  in  the  guaranteed  bonds  and  the  guar- 
anteeing company  must  have  become  actually  liable 
under  its  guaranty.  Should  the  guaranteed  bonds 
not  yet  be  due  and  the  guaranteeing  company  be- 
come insolvent  the  holders  of  the  guaranteed  bonds 
are  not  entitled  to  have  a  dividend  declared  in  their 


PRIORITIES  OF  THE  OTHER  CREDITORS     299 

favor  as  creditors  of  the  guaranteeing  company,  nor 
are  they  entitled  to  have  money  retained  in  court  to 
meet  a  possible  future  liability  on  the  guaranty. 
Nor  are  the  holders  of  the  guaranteed  bonds  entitled 
to  come  in  as  creditors  upon  the  reorganization  of 
the  guaranteeing  company.  But  a  provision  may 
be  properly  contained  in  the  agreement  of  guaranty 
entitling  the  holders  of  the  guaranteed  bonds  to 
prove  their  claims  as  creditors  of  the  guaranteeing 
company,  in  case  of  its  insolvency,  and  to  come  in 
as  creditors  upon  its  reorganization,  whether  or  not 
the  bonds  have  been  defaulted  by  the  issuing  com- 
pany and  whether  or  not  the  guaranty  has  become 
at  that  time  enforceable.  In  the  absence  of  such  an 
agreement,  the  holders  of  the  guaranteed  bonds  are 
not  entitled  to  prove  their  claims  against  the  guar- 
anteeing company  in  case  of  its  insolvency,  nor  to 
come  in  as  creditors  upon  its  reorganization,  until 
the  bonds  have  been  defaulted  by  the  issuing  com- 
pany and  the  guaranteeing  company  has  become 
liable  on  its  guaranty. 

Should  the  guaranteeing  company  pay  the  bonds 
under  its  guaranty,  it  is  entitled  to  be  reimbursed 
from  the  company  whose  bonds  it  has  thus  paid. 
The  guaranteeing  company  then  becomes  a  creditor 
of  the  latter  company  to  the  extent  of  its  payment 
on  its  guaranty.  It  is  then  entitled  to  all  the  rights 
that  the  holders  of  the  guaranteed  bonds  that  have 
been  paid  were  entitled  to,  as  such,  against  the  issu- 


300  RAILROAD  BONDS  AND  NOTES 

ing  company,  and  it  may  accordingly  enforce  the 
payment  of  the  bonds  it  has  thus  paid.  The  guar- 
anteeing company  then  takes  the  place  of  the  holders 
of  the  bonds  it  has  paid,  thus  becoming  a  creditor  of 
the  issuing  company. 

However,  should  the  guaranteeing  company  pay 
coupons  as  they  fall  due  and  then  hold  them  against 
the  issuing  company,  they  would  be  competing 
creditors  with  the  holders  of  the  guaranteed  bonds 
and  of  the  subsequently  maturing  guaranteed 
coupons.  The  guaranteeing  company  would  thus 
take  from,  such  holders  part  of  their  security.  To 
prevent  this  it  is  usually  arranged  that  should  the 
guaranteeing  company  pay  the  coupons,  the  trustee 
under  the  mortgage  shall  receive  the  coupons  so 
paid  and  cancel  them.  But  sometimes  the  guaran- 
teeing company  has  arranged  as  a  condition  of  its 
guaranty  that  should  it  pay  any  monies  under  its 
guaranty,  it  shall  be  entitled  to  receive  an  equal 
amount  of  interest  coupons,  and  that  on  foreclosure 
it  shall  be  entitled  to  payment  of  these  coupons  out 
of  the  mortgaged  property,  though  not  in  opposition 
to  or  in  diminution  of  the  claims  of  the  holders  of 
the  guaranteed  bonds  or  coupons.  In  this  way  the 
guaranteed  interest  is  paid  but  the  coupons  are  not 
canceled;  and  while  to  the  issuing  company  and  its 
other  creditors  these  coupons  are  considered  unpaid, 
as  to  the  holders  of  the  guaranteed  bonds  and  the 
other  coupons,  they  are  presumed  to  be  canceled 


PRIORITIES  OF  THE  OTHER  CREDITORS     301 

and  paid  and  not  to  be  enforced  so  as  to  conflict  or 
diminish  their  claims  in  any  way. 

It  is  not  part  of  the  ordinary  business  of  a  rail- 
road company  to  lend  its  credit  by  guaranteeing  the 
bonds  of  another  company.  Therefore,  it  is  neces- 
sary that  a  railroad  company  shall  have  the  power 
to  guarantee  the  bonds  of  another  railroad  company 
expressly  conferred  upon  it  as  it  is  not  one  of  the 
inherent  powers  ordinarily  possessed  by  railroad  cor- 
porations; but  the  courts  have  recognized  and  es- 
tablished the  rule  that  a  railroad  company  may 
guarantee  the  bonds  of  another  railroad  company 
when  the  power  to  do  so,  though  not  expressly 
given,  may  be  inferred  from  other  powers  and 
necessities. 

The  ownership  of  stock  in  a  subsidiary  company 
by  a  parent  company  empowers  the  latter  to  guar- 
antee the  bonds  of  the  former. 

If  the  railroad  company  have  the  power  to  con- 
solidate with  another,  it  has  the  power  to  guarantee 
the  bonds  of  such  corporation.  The  railroad  com- 
pany that  controls  another  by  lease,  may  guarantee 
the  bonds  of  the  latter.  Sometimes  the  guarantee- 
ing company  pays  the  interest  on  the  bonds  under  the 
contract  of  guaranty.  Where  the  guaranteeing 
company  pays  the  interest  on  the  bonds  of  the  road 
it  has  leased,  the  lease  may  provide  that  the  payment 
of  such  interest  shall  be  part  of  the  rental. 

The  guaranty  given  by  a  railroad  company  with- 


302  RAILROAD  BONDS  AND  NOTES 

out  any  power  to  make  the  contract  of  guaranty  is 
absolutely  void  and  cannot  be  enforced.  The  law 
thereby  protects  the  creditors  and  stockholders  of 
the  guaranteeing  company,  for  any  unauthorized  at- 
tempt at  guaranty  risks  the  capital  of  the  guarantee- 
ing company,  to  the  extent  of  the  guaranty,  in  the 
business  of  the  company  whose  bonds  are  guaran- 
teed; and  the  capital  of  the  guaranteeing  company 
is  to  that  extent  placed  under  the  control  of  the 
officers  of  the  guaranteed  company,  and  is  diverted 
from  the  purposes  of  its  own  affairs  to  which  its 
stockholders  and  creditors  are  entitled  to  have  it 
applied. 

But  the  doctrine  is  quite  generally  applied  that 
though  the  railroad  company  may  have  no  express 
power  to  guarantee  the  bonds  of  another  company, 
yet  if  the  power  to  do  so  may  be  implied  from  its 
other  powers,  or  is  reasonably  necessary  to  carry  out 
the  objects  for  which  it  is  in  business,  this  power  to 
guarantee  will  be  conceded  to  it. 

And  when  the  power  to  guarantee  is  contained  in 
the  charter  of  the  guaranteeing  company,  or  may  be 
implied  from  its  other  powers,  or  may  be  reasonably 
necessary  to  carry  out  the  purposes  of  its  incorpora- 
tion, then  its  stockholders,  bondholders,  and  other 
creditors  are  presumed  to  have  accepted  their  stock 
and  purchased  their  bonds  or  otherwise  extended 
their  credits,  respectively,  with  the  probability  that 


PRIORITIES  OF  THE  OTHER  CREDITORS     303 

the  capital  of  their  company  might  be  used  to  guar- 
antee the  bonds  of  other  companies. 

As  was  seen,  a  guaranty  given  by  a  railroad  com- 
pany that  did  not  have  the  requisite  power  is  void; 
however,  if  the  guaranteeing  company  had  the 
power,  but  did  not  exercise  it  properly,  it  may  not 
avoid  liability  by  reason  of  any  defect  in  the  execu- 
tion of  the  guaranty  and,  under  some  circumstances, 
it  may  be  enforced.  Where  the  intending  bond- 
holder acted  upon  the  faith  of  the  guaranty,  with- 
out knowledge  or  notice  of  any  defect,  he  can  claim 
the  full  benefits  of  it;  for  the  owner  of  the  guaran- 
teed bonds  is  ordinarily  entitled  to  rest  in  the  belief 
that  the  guaranteeing  company  has  properly  exer- 
cised its  powers  and  has  actually  done  all  it  should 
have  done  and  had  the  power  to  do.  The  guaran- 
teeing company  will  not  under  such  circumstances 
be  permitted  to  take  advantage  of  its  own  wrong  or 
mistake. 

However,  when  the  guaranty  is  beyond  its  powers 
it  is  void,  no  matter  how  correct  it  may  be  in  form. 
The  power  is  lacking.  In  the  first  case  the  company 
had  the  power  to  guaranty,  but  exercised  it  imper- 
fectly, and  the  court  corrects  that  error ;  in  the  latter 
case  the  company  did  not  have  any  power  to  guar- 
anty and  the  court  cannot  give  it,  for  that  is  a  func- 
tion of  the  legislature  only. 

The  guaranteeing  company  can  be  held  liable  on 


304  RAILROAD  BONDS  AND  NOTES 

its  contract  of  guaranty  only  when,  like  in  any  other 
contract  or  agreement,  it  has  received  something  as 
a  consideration  for  its  promise  of  guaranty.  If  the 
guaranty  be  given  before  the  execution  or  delivery 
of  the  bonds,  and  is  endorsed  on  the  bonds  before 
they  are  delivered,  the  purchase  price  of  the  bonds 
is  the  consideration  paid  for  them  and  also  for  the 
guaranty.  If  the  guaranty  be  given  after  the  execu- 
tion or  delivery  of  the  bonds,  the  guaranteeing  com- 
pany is  not  bound  by  the  terms  of  the  guaranty  un- 
less it  has  received  something  for  its  guaranty,  a 
"consideration"  as  the  legal  expression  is. 

Holders  of  guaranteed  bonds  should  see  that 
the  guaranteeing  company  consents  to  all  material 
changes  that  are  intended  to  be  made  in  the  bonds  or 
in  the  mortgage ;  for  any  change  in  these  instruments 
without  the  consent  of  the  guaranteeing  company 
will  discharge  it  from  further  liability.  A  material 
change  makes  it  a  different  contract  from  the  one 
that  was  guaranteed.  Whether  or  not  the  guaran- 
teeing company  is  injured  or  in  any  way  affected  by 
such  change  is  not  considered.  It  is  a  different  con- 
tract that  now  exists  and  is  not  the  one  that  was 
guaranteed.  The  contract  that  was  guaranteed  is 
no  longer  in  existence;  the  new  contract  resulting 
from  such  change  has  not  been  guaranteed. 

Should  the  time  for  the  payment  of  the  principal 
or  interest  be  extended  without  the  consent  of  the 
guaranteeing  company,  it  is  discharged  from  lia- 


PRIORITIES  OF  THE  OTHER  CREDITORS     305 

bility.  But  the  extension  must  be  pursuant  to  an 
agreement  for  a  definite  time  and  not  a  mere  for- 
bearance to  enforce  remedies  for  a  reasonable  time. 
Whether  or  not  the  extension  of  time  caused  any 
injury  to  the  guaranteeing  company  is  not  con- 
sidered; the  time  for  the  payment  that  was  guaran- 
teed has  been  changed  and  the  contract  as  guaran- 
teed no  longer  exists,  and  it  is  released  from  liability 
on  its  guaranty. 

When  new  bonds  have  been  substituted  for  the 
ones  that  have  been  guaranteed,  the  guaranteeing 
company  is  released,  unless  a  new  guaranty  is  given. 
The  old  guaranty  is  at  an  end. 

Holders  of  guaranteed  railroad  bonds,  however, 
do  not  release  the  guaranteeing  company  where  they 
take  additional  security  for  their  bonds,  provided 
there  is  no  extension  for  the  time  of  payment  of  the 
guaranteed  bonds  nor  any  material  changes  made  in 
the  original  contract. 

But  if  in  addition  to  the  guaranty  and  at  the  time 
it  was  given,  the  holders  of  the  guaranteed  bonds 
have  other  security  and  surrender  the  same,  thus 
throwing  the  entire  burden  on  the  guaranteeing  com- 
pany, it  works  a  release  of  the  latter  to  the  extent  of 
the  amount  that  it  has  been  injured  by  the  surrender 
of  such  other  security.  However,  in  a  contract  of 
guaranty,  like  all  others,  the  courts  in  construing 
them  try  to  find  from  their  language  just  what  the 
parties  intended,  and  if  from  the  contract  it  appears 


306  RAILROAD  BONDS  AND  NOTES 

that  the  bondholders  have  in  their  possession  or  con- 
trol securities  from  which  their  claims  can  be  col- 
lected, and  that  it  may  be  reasonably  presumed  that 
it  was  intended  that  these  securities  should  be  used 
up  before  the  guaranteeing  company  should  be  asked 
to  pay,  the  court  will  direct  that  such  collateral 
security  be  first  exhausted.  But  if  the  guaranty  be 
an  absolute  one  and  no  such  intention  as  just  men- 
tioned can  be  spelled  from  its  terms  then  the  holders 
of  the  guaranteed  bonds  may  proceed  against  the 
guaranteeing  company  without  first  trying  to  realize 
out  of  such  collateral  securities.  The  language  of 
the  guaranty  is  of  prime  importance.  It  should  be 
carefully  noted  whether  the  guaranty  is  to  the  effect 
that  the  guaranteeing  company  will  pay  as  soon  as 
the  issuing  company  has  defaulted,  or  that  if  the 
monies  due  from  the  issuing  company  cannot  be  col- 
lected from  it,  then  it  will  pay. 

The  language  of  the  guaranty  in  this  particular 
should  be  closely  examined.  If  it  is  to  the  effect 
that  the  bonds  and  the  coupons  shall  be  paid  when 
they  severally  fall  due,  it  is  an  absolute  guaranty 
and  immediately  upon  the  default  of  the  issuing 
company,  the  guaranteeing  company  becomes  liable. 
No  act  on  the  part  of  the  bondholders  or  their  trus- 
tee in  their  behalf  is  necessary  to  fix  the  liability  of 
the  guaranteeing  company. 

The  guarantee,  however,  may  be  that  the  princi- 
pal and  interest,  or  either,  as  the  case  may  be,  will 


PRIORITIES  OF  THE  OTHER  CREDITORS      307 

be  collected  from  the  issuing  company.  This  is  a 
guaranty  of  collection  and  a  different  situation  pre- 
sents itself.  The  guaranteeing  company  under  such 
a  guaranty  becomes  liable  only  after  a  failure  to  col- 
lect from  the  issuing  company.  Under  the  guaranty 
of  payment,  the  guaranteeing  company  becomes 
liable  immediately  upon  the  failure  of  the  issuing 
company  to  pay  according  to  the  terms  of  the  bonds, 
and  the  mortgage  if  there  be  one. 

In  the  guaranty  of  collection,  the  rule,  rather 
broadly  stated,  is  that  all  reasonable  effort  must  be 
made  and  legal  remedies  pursued  to  collect  from  the 
issuing  company,  and  then  upon  a  failure  to  thus 
realize,  the  guaranteeing  company  becomes  liable 
for  such  sums  as  are  still  unpaid.  In  some  States 
the  insolvency  of  the  issuing  railroad  company  re- 
lieves the  holders  of  the  guaranteed  bonds  from  the 
duty  of  demanding  payment  of  the  company  directly 
liable  and  pursuing  their  remedies  against  it,  in  order 
to  hold  the  guaranteeing  company  liable. 

The  usual  form  of  guaranty  is  substantially  to  the 
effect  that  the  guaranteeing  company  agrees  with 
whomsoever  may  be  the  holders  of  the  bonds  or  the 
coupons,  as  the  case  may  be,  at  the  time  the  guaran- 
tee is  to  be  enforced,  that  the  issuing  company  will 
pay  the  principal  of  the  bonds  at  maturity,  or  their 
interest  coupons  attached,  as  they  severally  fall  due, 
and,  therefore,  is  an  absolute  guaranty  of  payment, 
and  the  liability  of  the  guaranteeing  company  be- 


308  RAILROAD  BONDS  AND  NOTES 

comes  fixed  immediately  upon  the  default  of  the 
issuing  company,  without  any  preliminary  steps. 

Guaranteed  bonds  are  sometimes  judged  by  the 
strength  of  the  guaranteeing  company.  Undoubt- 
edly, if  the  principal  and  interest  are  guaranteed, 
without  any  limitation  of  liability,  it  is  a  valuable 
asset  when  written  by  a  strong  company.  But  the 
guaranty  is  sometimes  given  a  false  value  on  account 
of  the  feeling  of  safety  that  the  word  may  impart. 
The  intrinsic  value  of  the  bond,  the  legal  strength 
of  the  guaranty  and  the  financial  strength  of  the 
guaranteeing  company  should  be  the  subjects  of  in- 
quiry and  examination.  The  bond  should  stand  on 
its  own  merits. 

Stamped  bonds. 

Where  a  parent  company  guarantees  the  out- 
standing bonds  of  its  subsidiary  company  to  enable 
it  to  build  a  branch  line,  it  will  do  so  sometimes  by 
stamping  its  guaranty  on  the  bonds.  That  is,  old 
bonds  of  an  outstanding  issue  are  endorsed  with  the 
guaranty  by  stamping.  See  Guaranteed  bonds. 
Page  293. 

In  some  issues,  certain  privileges  or  rights  thereto- 
fore possessed  by  the  holders  of  the  bonds  according 
to  the  terms  of  the  bond  or  the  mortgage  may  be 
modified  or  other  changes  necessitated  by  conditions 
arising  since  the  issue  was  put  out.  These  changes 
are  usually  brought  about  by  a  reorganization  of 


PRIORITIES  OF  THE  OTHER  CREDITORS     309 

the  railroad.     These  changes  in  the  bond  or  the 
mortgage  are  then  stamped  on  the  bonds. 

A  reference  to  a  bond  as  a  "stamped"  bond  is 
notice  to  all  intending  purchasers  that  there  is  some- 
thing added  to  it  on  mutual  consent  by  stamping 
that  changes  the  original  bond  or  mortgage  in  some 
particular.  The  contract  originally  made  between 
the  holder  and  the  issuing  company  and  the  trustee 
is  thus  changed  and  the  change  stamped  upon  the 
bond. 

Assumed  bonds. 

These  are  the  bonds  of  a  subsidiary  company  that 
have  been  assumed  by  the  parent  company  when  it 
takes  over  the  ownership  or  control  of  such  sub- 
sidiary company. 

The  parent  company  may  take  over  the  bonds  of 
its  subsidiary  company  and  make  them  its  own  direct 
obligation;  or  it  may  guarantee  such  bonds  upon  the 
issuing  company  becoming  a  part  of  the  system  of 
the  parent  company  or  being  controlled  by  it. 

Where  the  parent  company  assumes  the  bonds,  it 
makes  them  its  own  obligation,  they  then  have  the 
same  force  as  if  it  had  originally  issued  them,  with 
the  exception  that  its  liability  dates  from  the  time 
it  assumed  the  bonds  and  not  from  the  date  they  were 
issued  or  put  out.  If  its  liability  were  to  date  back 
to  the  time  of  issue,  it  might  thereby  deprive  those 
of  its  creditors  who  may  in  the  meantime  have 


310  RAILROAD  BONDS  AND  NOTES 

obtained  rights  against  its  property,  of  their  rights. 
Should  the  parent  or  other  company  that  assumes 
the  bonds  give  no  mortgage  or  other  security,  then 
the  holders  of  such  assumed  bonds  are,  so  far  as  the 
assuming  company  is  concerned,  merely  general  or 
unsecured  creditors.  As  such  they  can  only  satisfy 
their  claims  against  such  assuming  company  after  all 
mortgages  or  other  liens  against  its  property  have 
been  satisfied  in  full.  As  to  property  of  such  as- 
suming company  against  which  there  are  no  mort- 
gages or  other  liens,  they  share  proportionately  with 
the  other  general  or  unsecured  creditors.  See  Gen- 
eral rules  of  distribution;  secured  and  unsecured 
creditors.  Page  227. 

Terminal  bonds. 

Terminal  bonds  are  secured  by  a  mortgage  on  ter- 
minal property. 

Railroad  companies  often  do  not  own  the  terminal 
property  they  use.  Such  property  may  be  owned  by 
one  or  more  railroad  companies  and  used  with  sev- 
eral others  in  common.  When  all  the  railroad  com- 
panies that  use  the  terminal  property  also  own  it, 
the  bonds  usually  are  the  direct  obligation  of  such 
owners  and  are  secured  by  a  mortgage  on  that  ter- 
minal property.  For  security  the  holder  of  such 
bonds  is  limited,  of  course,  to  such  terminal  property 
that  has  been  mortgaged  and  if  that  be  insufficient 
to  satisfy  his  claim,  as  to  the  balance  he  is  a  general 


PRIORITIES  OF  THE  OTHER  CREDITORS      311 

or  unsecured  creditor  of  the  issuing  railroad  com- 
panies. See  Secured  and  unsecured  creditors. 
Page  227. 

When  several  railroad  companies  use  terminal 
property  in  common,  and  only  one  or  more  but  not 
all  own  that  property,  the  road  or  roads  owning  the 
terminal  property  may  issue  the  bonds,  making  them 
their  direct  obligations,  and  then  execute  a  mort- 
gage charging  such  terminal  property  with  the  pay- 
ment of  such  bonds.  The  other  roads  that  do  not 
own  the  terminal  property,  but  which  use  it  in  com- 
mon, may  guaranty  such  bonds  as  to  principal  or 
interest,  or  both.  The  strength  of  this  guaranty  de- 
pends upon  the  form  that  the  guaranty  takes  to- 
gether with  the  standing  of  the  company  or  com- 
panies behind  it.  The  holders  of  such  terminal 
bonds  then  can  look  to  such  terminal  property  that 
has  been  mortgaged  to  secure  them.  For  any  un- 
paid balance  they  are  general  or  unsecured  creditors 
of  the  issuing  company,  and  they  may  also  charge 
the  guaranteeing  company  upon  its  guaranty. 

Terminal  bonds  are  sometimes  the  obligation  of  a 
terminal  company  that  owns  only  the  terminal  prop- 
erty. That  is,  a  separate  corporation  is  incorporated 
to  hold  only  such  terminal  property.  The  capital 
stock  of  the  terminal  company  is  usually  held  en- 
tirely by  the  roads  using  the  terminal  property. 
They  thus  control  and  practically  own  the  terminal 
company. 


312  RAILROAD  BONDS  AND  NOTES 

The  terminal  company  then  issues  its  bonds  se- 
cured by  a  mortgage  on  its  property.  These  bonds 
are  sometimes  guaranteed  by  the  railroad  companies 
using  this  terminal  property.  Recourse  can  then 
only  be  had  against  the  mortgaged  property,  i.e., 
the  terminal  property  and  the  terminal  company. 
The  liability  of  the  roads  using  the  property  is 
limited  to  the  guaranties  that  may  have  been  given. 

The  terminal  company  may  not  be  owned  or  con- 
trolled by  the  railroad  companies  using  its  proper- 
ties. It  may  be  an  independent  and  separate  com- 
pany having  no  relation  with  the  roads  using  its 
terminal  property  other  than  of  lessor  and  lessee. 
Its  bonds  may  then  be  only  its  own  direct  obligation 
without  any  guaranty  from  such  roads.  The  source 
of  income  then  from  which  it  pays  the  interest  on  its 
bonds  and  meets  its  other  obligations  and  expenses, 
is  the  rental  it  receives  from  the  roads  using  its 
property.  Though  under  the  circumstances  just  set 
forth,  the  road  or  roads  using  this  property  may  also 
guarantee  the  bonds  issued  by  this  separate  terminal 
corporation.  See  Guaranteed  bonds.  Page  293. 

Bonds    relating    to    development;    development 
bonds. 

As  the  name  suggests  "development"  bonds  are  is- 
sued to  raise  money  for  the  development  of  the  road. 

The  railroad  company  is  obligated  by  the  terms  of 
its  mortgage  securing  such  an  issue,  to  use  the  money 


PRIORITIES  OF  THE  OTHER  CREDITORS     313 

thus  raised  for  such  purpose,  and  can  be  compelled 
to  do  so  and  can  be  restrained  from  using  it  for  an- 
other object.  In  the  mortgage  the  particular  im- 
provement, betterment,  or  addition  to  be  made, 
which  enhances  the  value  of  the  road  beyond  mere 
repairs,  is  specified.  It  is  usually  set  forth  in  the 
mortgage  that  the  money  shall  be  turned  over  to 
the  railroad  company  by  the  trustee,  in  instalments 
of  fixed  amounts,  from  time  to  time,  as  the  work 
progresses. 

The  nature  and  value  of  the  mortgage  that  secures 
this  issue  must  be  examined  into.  A  mortgage  of 
this  kind  depends  upon  the  circumstances  under 
which  the  issue  is  put  out,  the  condition  of  the  road, 
and  the  property  pledged  to  its  payment. 

The  mortgage  that  secures  a  development  issue 
may  create  a  lien  on  all  or  on  only  a  small  portion 
of  the  road;  or  its  lien  may  attach  only  to  the  de- 
velopment or  addition.  Its  lien  may  be  first  as  to  a 
part  of  the  mortgaged  property  (the  improvement 
or  addition)  and  an  inferior  and  junior  lien  as  to 
the  other  parts;  or  it  may  be  a  lien  on  all  the  prop- 
erty covered  by  the  mortgage  but  of  inferior  and 
junior  rank  to  whatever  liens  that  may  already  exist 
against  such  property.  The  legal  rank  of  such  a 
mortgage  and  the  property  it  covers  is  always  a  mat- 
ter for  inquiry. 

Money  for  development,  repairs,  or  additions  is 
quite  generally  raised  by  means  of  a  general  or 


RAILROAD  BONDS  AND  NOTES 

blanket  mortgage.  Such  mortgages  are  made  liens 
upon  all  the  property  of  the  road  and  are  for  sums 
large  enough  to  meet  the  present  needs  of  the  com- 
pany, including  developments,  its  future  require- 
ments, and  also  to  take  up  prior  mortgages.  See 
General  mortgage  bonds;  blanket  mortgage  bonds. 
Page  269. 

Extension  bonds. 

When  a  road  builds  an  extension  to  its  own  line, 
the  bonds  with  which  the  building,  maintenance, 
and  operation  of  this  extension  are  to  be  financed 
are  sometimes  referred  to  as  "extension  bonds." 
The  custom  is  to  have  the  extension  built  and  oper- 
ated by  a  company  incorporated  for  that  very  pur- 
pose, thus  creating  a  distinct  legal  body  which  is 
separate  from  the  main  or  parent  road  whose  exten- 
sion it  shall  be. 

This  separate  corporation  then  gives  its  mortgage 
on  the  new  extension  which  constitutes  its  entire 
property.  This  mortgage  is  usually  a  first  lien  on 
such  property.  The  parent  company  usually  guar- 
antees these  so  called  extension  bonds.  See  Guar- 
anteed bonds.  Page  293.  Also  see  Collateral  trust 
bonds.  Page  277. 

Bonds  to  construction  company. 

Branch  lines  or  extensions  are  sometimes  con- 
structed by  persons  individually,  or  by  a  partner- 


PRIORITIES  OF  THE  OTHER  CREDITORS     315 

ship,  or  a  corporation  sometimes  formed  for  that 
purpose.  The  road  or  extension  is  thus  constructed 
and  then  turned  over  complete  to  the  parent  com- 
pany. 

In  payment  for  such  construction,  the  contractors 
receive  securities  issued  against  such  branch  or  ex- 
tension. 

These  securities  may  be  the  stocks  or  bonds,  or 
both,  of  the  corporation  in  the  name  of  which  the 
branch  or  extension  is  held,  and  issued  by  it,  the 
bonds  being  secured  by  a  mortgage  on  such  branch 
or  extension;  or  the  parent  company  may  hold  the 
branch  or  extension  in  its  own  name,  in  which  case 
it  will  issue  its  own  direct  obligations;  or  the  new 
company  in  the  name  of  which  the  branch  line  or 
extension  is  held  may  issue  its  own  bonds  secured  by 
a  mortgage  on  such  branch  or  extension  and  guaran- 
teed by  the  parent  company.  See  Collateral  trust 
bonds.  Page  277;  see  also  Guaranteed  bonds. 
Page  293. 

The  advantage  to  the  parent  company  in  such  an 
arrangement  is  that  it  is  relieved  of  the  work  of  con- 
struction and  also  relieved  of  the  financing  of  the 
securities  of  the  branch  or  extension  company.  The 
advantage  to  the  construction  company  is  that  it 
makes  a  profit. 

The  thought  should  be  present  that  there  is  the 
temptation  for  the  constructors  in  marketing  the  se- 
curities they  have  thus  acquired,  to  make  a 


316  RAILROAD  BONDS  AND  NOTES 

"watered"  profit;  and  that  should  the  officers  of  the 
railroad  company  be  the  same  as  those  of  the  con- 
struction company,  or  should  other  friendly  relations 
exist  between  them,  there  is  that  opportunity  to 
make  an  inside  profit  against  which  frail  man  is  not 
always  immune. 

Car  trust  certificates  or  bonds ;  equipment  trust  cer- 
tificates or  bonds. 

Car  trust  certificates  or  bonds,  equipment  trust 
certificates  or  bonds,  and  equipment  bonds  are  se- 
cured by  mortgages  against  cars  or  equipment 
only. 

There  is  no  difference  between  the  bond  and  the 
certificate  in  these  instances;  they  are  the  same  in- 
struments substantially.  The  terms  as  here  em- 
ployed are  practically  synonymous. 

Equipment  bonds  are  issued  by  the  railroad  com- 
pany and  are  its  own  direct  obligations.  Car  trust 
bonds  or  certificates  and  equipment  trust  bonds  or 
certificates  are  the  result  of  a  trust  arrangement,  as 
the  name  suggests,  and  are  not  issued  by  the  railroad 
company.  They  are  issued  by  and  are  the  obliga- 
tion of  the  trustee  who  holds  the  cars  or  the  equip- 
ment, as  the  case  may  be,  under  the  trust  plan. 

In  all  these  cases,  however,  the  mortgage  is  against 
the  cars  or  equipment,  the  legal  title  and  ownership 
is  held  by  the  trustee,  while  the  railroad  company 
has  the  possession  and  the  use  of  such  property. 


PRIORITIES  OF  THE  OTHER  CREDITORS     317 

Under  the  car  trust  arrangement,  the  railroad  com- 
pany pays  a  yearly  rental  for  the  use  of  the  cars 
which  is  employed  to  annually  pay  off  the  bonds  in 
serials :  and  in  the  case  of  the  equipment  bonds,  the 
direct  obligations  of  the  railroad  company,  it  pays 
off  and  retires  a  certain  proportion  of  the  issue  each 
year.  In  both  cases,  having  in  mind  the  deteriora- 
tion of  the  value  of  the  cars  and  the  equipment,  the 
bonded  indebtedness  is  thus  reduced  as  fast,  if  not 
faster,  than  the  property  diminishes  in  value.  See 
Equipment  bonds.  Page  323. 

Car  trust  certificates  or  bonds  result  from  a  car 
trust  arrangement  which  is  sometimes  called  the 
Philadelphia  Plan. 

This  trust  arrangement  or  plan  is  employed  when 
the  railroad  company  needs  cars  which  it  does  not 
wish  to  purchase  outright  as  that  would  mean  the 
immediate  outlay  of  money  that  often  must  first  be 
raised.  Should  the  railroad  company  take  title  to 
the  cars  they  may  fall  under  and  be  included  within 
an  after  acquired  property  clause  in  a  mortgage  al- 
ready existing  against  the  road  and  thus  not  furnish 
a  security  to  raise  money  for  their  purchase;  or  they 
may  in  some  other  way  become  subject  to  the  attack 
of  the  creditors  of  the  company.  The  common  pur- 
pose of  the  car  trust  plan  is,  no  matter  what  the  other 
considerations  may  be,  that  they  shall  furnish  the 
security  for  and  be  the  means  of  raising  the  money 
necessary  in  large  part  for  their  own  purchase. 


318  RAILROAD  BONDS  AND  NOTES 

Accordingly,  an  association  is  formed  by  capital- 
ists purposely  to  build,  or  to  have  built,  or  to  buy 
from  others,  the  cars  in  question.  A  mortgage  is 
made  against  these  cars  to  a  trustee  and  the  title  to 
them  is  transferred  to  him.  The  trustee  now  holds 
the  legal  title  to  the  cars  subject  to  the  terms  of  this 
mortgage.  He  enters  into  a  lease  with  the  railroad 
company  by  which  the  cars  are  leased  to  the  latter 
for  a  specified  period,  usually  ten  years. 

The  railroad  company,  under  the  lease,  has  the 
possession  of  the  cars  and  the  right  to  use  them,  and 
pays  an  annual  rental  therefor.  These  rentals  are 
considered  as  instalments  of  the  purchase  price,  and 
when  the  last  instalment  is  paid,  the  railroad  com- 
pany becomes  the  owner  of  the  cars. 

Until  the  last  instalment  of  this  rent  is  paid  to 
the  trustee  he,  in  behalf  of  the  holders  of  the  cer- 
tificates or  bonds,  continues  to  own  the  cars. 

The  association  which  supplied  the  trustee  with 
the  cars  in  question  originally,  receives  its  return  for 
the  manufacture  or  purchase,  as  the  case  may  be,  by 
the  sale  of  these  bonds  or  certificates  and  the  cash 
payment  that  the  railroad  company  makes. 

The  railroad  company  pays  in  cash  a  certain  pro- 
portion, usually  twenty  per  centum,  of  the  value  of 
the  cars  at  the  time  they  are  turned  over  to  it,  and 
the  trustee  issues  his  car  trust  certificates  or  bonds 
for  the  balance,  which  is  usually  eighty  per  centum. 

Having  in  kind  the  deterioration  in  the  value  of 


PRIORITIES  OF  THE  OTHER  CREDITORS     319 

the  cars,  the  certificates  are  issued  in  serials.  The 
issue  is  usually  divided  into  as  many  serials  as  the 
lease  has  years  to  run  and  one  serial  falls  due  each 
year.  The  lease  runs  for  ten  years  usually.  It  is 
aimed  to  have  the  bonds  paid  off  quicker  than  the 
property  will  depreciate.  The  indebtedness  must 
diminish  at  a  faster  rate  than  does  the  value  of  the 
property. 

The  rental  is  paid  to  the  trustee.  This  rental  is 
usually  such  an  amount  as  will  pay  the  expenses  of 
the  trusteeship,  yearly  taxes,  etc.,  the  interest  on  the 
outstanding  certificates  or  bonds  of  the  issue  and  to 
retire  the  serials  as  they  severally  fall  due. 

The  railroad  company  agrees  to  keep  this  property 
in  good  repair  and  to  replace  destroyed  or  worn  out 
parts.  It  also  agrees  to  keep  this  property  properly 
insured.  The  trustee  has  the  right  to  inspect  the 
cars  during  the  period  of  the  lease  to  see  that  they 
are  not  being  neglected. 

Upon  default  by  the  railroad  company  in  the 
payment  of  the  rental,  or  other  breach  of  its  agree- 
ment, the  trustee  may  usually,  under  the  terms  of 
the  lease,  retake  the  property  and  dispose  of  it  as  is 
therein  specified.  And  upon  such  default  it  is  usu- 
ally agreed  in  the  lease  that  the  railroad  company 
shall  forfeit  all  monies  already  paid  and  shall  con- 
tinue liable  for  all  rent  then  due  and  not  paid. 

The  cars  while  in  the  possession  of  the  railroad 
company  and  used  by  it  are  not  subject  to  the  claims 


320          RAILROAD  BONDS  AND  NOTES 

of  any  of  its  creditors,  for  the  trustee  owns  the 
property. 

When  there  is  a  default  by  the  railroad  company, 
as  was  seen,  the  trustee  is  entitled  to  seize  the  cars 
from  the  railroad  company.  However,  private 
rights  must  sometimes  give  way  to  public  interests, 
and  when  a  railroad  company  becomes  insolvent  and 
a  receiver  is  appointed  to  operate  the  road,  the  court 
may  order  that  he  continue  the  use  of  these  cars. 
The  fact  that  the  receiver  continues  to  use  the  cars 
does  not  make  the  lease  binding  upon  him.  He  may 
accept  or  reject  the  lease  made  by  the  road  that  he 
now  operates,  under  order  of  the  court,  as  the  inter- 
ests he  serves  demands. 

Notwithstanding  that  the  receiver  rejects  the 
lease  and  refuses  to  be  bound  by  its  terms,  he  may 
nevertheless  use  the  cars.  He  then  pays  a  reason- 
able value  for  their  use  during  the  time  he  actually 
used  them.  The  reasonable  value  he  pays  may  or 
may  not  be  the  same  amount  as  is  mentioned  in  the 
lease  as  the  rental.  When  the  receiver  has  finished 
with  these  cars  he  turns  them  over,  under  the  order 
of  the  court,  to  the  trustee  under  the  lease. 

Where  the  railroad  company  has  already  paid  a 
substantial  part  of  the  entire  amount  of  rentals 
under  the  lease,  the  court  may  order  that  the  re- 
ceiver continue  and  pay  the  balance  and  complete 
the  transaction,  whereupon  the  railroad  company 
becomes  the  absolute  owner  of  the  cars. 


PRIORITIES  OF  THE  OTHER  CREDITORS     321 

Should  only  a  small  portion  of  the  purchase  price 
or  rentals  have  been  paid,  it  is  doubtful  if  the  court 
will  order  the  receiver  to  pay  the  balance  and  com- 
plete the  transaction.  The  rentals  paid  by  the  re- 
ceiver are  regarded  as  expenses  of  the  receivership 
and  like  all  such  expenses  are  paid  in  full  before  the 
holders  of  the  bonds  under  the  foreclosed  mortgage 
received  anything. 

When  property  is  sold  under  a  "conditional"  sale, 
the  possession  of  such  property  is  given  over  to  the 
buyer  but  the  title  and  ownership  of  it  continues  in 
the  seller  until  the  buyer  has  paid  the  full  purchase 
price,  whereupon  the  buyer  becomes  the  owner. 
See  Conditional  sales.  Page  255. 

The  car  trust  arrangement  is  sometimes  called  the 
Philadelphia  Plan  as  it  originated  there,  because  the 
laws  of  Pennsylvania  declared  that  a  conditional 
sale,  as  above  described,  is  void  as  to  the  creditors  of 
the  buyer  and  that  they  (such  creditors)  are  entitled 
to  take  such  property  from  the  buyer  in  whose  pos- 
session they  find  it  in  satisfaction  of  their  claims 
just  as  if  he  were  the  actual  owner.  This  is  the  law 
quite  generally  in  all  the  States,  in  the  absence  of 
notice  or  knowledge  on  the  part  of  the  creditors  that 
the  actual  ownership  is  not  in  such  buyer. 

The  reason  for  this  rule  is  that  the  creditors  of  the 
buyer  who  has  this  property  in  his  possession  with 
all  the  signs  of  apparent  ownership,  may  be  misled 
into  believing  that  such  buyer  actually  owns  this 


322  RAILROAD  BONDS  AND  NOTES 

property  and  thereby  may  have  been  induced  to  have 
given  him  credit.  The  usual  method  of  avoiding 
such  a  situation  when  property  is  sold  under  such 
conditions  is  to  give  notice  to  the  world  that  the 
title  and  ownership  is  still  in  the  seller  and  that  the 
buyer  merely  has  the  right  to  use  the  property. 
This  is  done  by  recording  the  instrument  containing 
the  arrangement  of  the  conditional  sale  in  the  office 
of  the  public  official  designated  by  law  for  that  pur- 
pose, usually  the  register  or  the  clerk  of  the  county 
in  which  the  property  is. 

In  most  States  there  are  laws  providing  that  the 
lease  or  conditional  sale  of  cars  of  a  railroad  shall  be 
valid  only  if  such  lease  or  contract  is  in  writing  and 
thus  publicly  recorded,  or  when  the  name  of  the  asso- 
ciation, lessor  or  seller,  appears  on  both  sides  of  each 
car  covered  by  such  arrangement.  This  is  notice  of 
the  true  ownership  and  no  one  is  misled.  Failure 
to  observe  these  requirements  will  in  most  cases 
make  the  sale  or  lease  void  as  to  the  creditors  of 
the  railroad  company  and  they  will  be  entitled  then 
to  claim  such  property  in  satisfaction  of  their 
claims. 

The  car  trust  certificates  or  bonds  are  limited  to 
those  transactions  where  cars  are  involved. 

When  other  equipment  and  cars  or  other  equip- 
ment alone  is  the  subject  matter  of  the  arrangement 
the  issue  is  usually  called  "equipment  trust"  bonds  or 
certificates.  The  details  of  the  arrangement  are  the 


PRIORITIES  OF  THE  OTHER  CREDITORS      323 

same  as  in  the  case  of  the  car  trust  certificates  or  bonds. 
Car  trust  certificates  or  bonds  or  equipment  trust 
certificates  or  bonds  are  in  coupon  form  as  a  rule, 
with  the  privilege  of  registering  the  principal. 

Equipment  bonds. 

Sometimes  instead  of  the  trust  arrangement  or 
Philadelphia  Plan,  the  railroad  company  may  pur- 
chase or  own  equipment  outright  and  execute  its 
mortgage  against  it  to  raise  money ;  under  such  mort- 
gage the  title  to  such  equipment  is  conveyed  to  the 
trustee,  and  he  holds  it  for  the  benefit  of  the  holders 
of  the  equipment  bonds  to  be  issued. 

Should  the  railroad  company  buy  the  equipment 
itself,  it  pays  in  cash  usually  about  twenty  per 
centum  of  its  value  and  raises  the  balance  by  selling 
equipment  bonds,  its  own  direct  obligation,  secured 
by  mortgage  against  such  equipment.  This  mort- 
gage is  invariably  a  first  lien  against  such  property. 

Equipment  bonds  are  issued  by  the  railroad  com- 
pany for  about  eighty  per  centum  of  the  value  of  the 
equipment.  They  are  the  direct  obligations  of  the 
railroad  company  and  run  for  ten  years  as  a  general 
rule.  They  fall  due  serially.  The  issue  is  divided 
into  as  many  serials  as  the  issue  has  years  to  run. 
One  serial  falls  due  each  year.  The  purpose  of  this 
is  to  have  the  bonds  paid  off  at  a  faster  rate  than  the 
equipment  will  depreciate  in  value. 

In  the  meantime  the  railroad  company  has  the  pos- 


324  RAILROAD  BONDS  AND  NOTES 

session  and  use  of  the  equipment,  though  the  title 
thereto  and  the  ownership  thereof  is  in  the  trustee 
for  the  purposes  set  forth  in  the  mortgage.  Should 
the  railroad  company  default  in  any  payment,  it  is 
provided  in  the  mortgage  and  in  the  lease  that  the 
trustee  may  proceed  against  this  equipment,  seize  the 
same  and  realize  thereon  for  all  claims  under  his 
mortgage. 

Bonds  growing  out  of  the  reorganization  or  read- 
justment of  the  railroad  company  generally. 

In  the  reorganization  or  readjustment  of  the  af- 
fairs of  a  railroad  company  that  is  financially  em- 
barrassed, and  in  order  to  help  it  retrieve  its  stand- 
ing, bondholders  and  other  creditors  of  the  road 
sometimes  give  up  certain  of  their  rights  or  consent 
to  have  them  modified  (See  Assented  bonds.  Page 
325);  or  waive  the  lien  or  priority  of  their  mort- 
gage in  favor  of  a  later  issue  of  mortgage  bonds 
(See  Prior  lien  bonds.  Page  326) ;  or  consent  to 
scale  or  reduce  their  claims,  in  the  case  of  bond- 
holders, consenting  to  accept  bonds  for  a  less  amount 
or  for  a  lower  rate  of  interest  (See  Scaling.  Page 
328) ;  or  accept  bonds  of  the  newly  reorganized  cor- 
poration or  shares  of  its  capital  stock;  or  agree  to 
extend' the  time  for  the  payment  of  their  bonds  or 
notes  (See  Extended  bonds  or  notes.  Page  327); 
or  the  secured  bondholders  may  give  up  their  secur- 


PRIORITIES  OF  THE  OTHER  CREDITORS     325 

ity  and  in  return  have  pledged  to  them  the  income 
of  the  road  to  pay  the  interest  on  their  bonds  (See 
Income  bonds.  Page  329),  the  principal  of  which 
may  or  may  not  be  secured.  The  interest  of  the  in- 
come bonds  is  payable  out  of  the  income  of  the  road 
only  when  it  is  earned;  if  income  be  not  earned  the 
bonds  receive  no  interest. 

Assented  bonds. 

Where  it  is  attempted  to  reorganize  the  road  or 
to  readjust  its  affairs,  the  plan  for  such  reorganiza- 
tion or  readjustment  is  usually  submitted  to  the 
stockholders  and  the  holders  of  the  bonds  of  the  dif- 
ferent issues.  This  plan  may,  and  it  usually  does, 
call  for  an  assessment  from  the  stockholders  or  some 
concession  from  the  bondholders  or  holders  of  notes. 
Should  the  holders  of  such  bonds  or  notes  assent  to 
such  plan,  they  submit  their  bonds  or  notes,  as  the 
case  may  be,  to  the  designated  depositary  and  have 
stamped  thereon  the  fact  that  the  owner  of  such  bond 
or  note  has  assented  to  such  plan.  These  bonds  or 
notes  are  then  called  "assented"  bonds  or  notes  and 
all  later  holders  take  them  subject  to  all  the  changes 
in  the  original  terms  of  the  bonds  or  notes,  and  in 
their  mortgage  where  they  are  secured. 

The  assent  becomes  an  incident  of  the  bond  or 
note  and  passes  with  it  in  each  transfer  thereafter, 
and  affects  the  rights  of  every  subsequent  holder. 


326  RAILROAD  BONDS  AND  NOTES 

Prior  lien  bonds;  preferential  bonds. 

The  holders  of  the  bonds  of  an  insolvent  road  may 
consent  that  a  new  issue  of  bonds  be  put  out  to 
raise  money  to  place  the  company  on  a  hopeful  basis, 
and  that  such  issue  shall  have  priority  over  their 
own  bonds  in  payment  out  of  the  property  mort- 
gaged to  secure  them.  That  is,  this  new  issue  shall 
be  secured  on  the  same  property  as  their  bonds  and, 
though  later,  shall  be  paid  first.  When  bonds  are 
thus  given  a  prior  lien  by  being  thus  preferred  they 
are  called  "prior  lien"  bonds  or  "preferential" 
bonds. 

It  should  be  noted  that  the  fact  that  they  are 
given  a  preference  and  made  a  prior  lien  does  not 
necessarily  make  them  a  first  lien  and  prior  to  all 
other  bonds.  It  means  that  the  preference  or  prior- 
ity thus  given  has  reference  only  to  the  holders  of 
those  bonds  who  have  consented  to  defer  their  own 
bonds.  This  consent  is  usually  given  because  it  is 
generally  believed  that  with  the  aid  of  the  funds  thus 
raised,  the  consenting  bondholders,  notwithstand- 
ing the  waiving  of  their  lien  in  favor  of  the  new 
bonds,  will  in  the  end  be  benefited  by  the  results 
produced  by  the  money  thus  raised.  However,  as 
to  those  who  do  not  consent,  the  new  bonds  do  not 
get  this  preference  or  priority,  and  the  non-assenting 
bondholders  retain  their  original  priority  of  lien,  and 
are  unaffected  by  such  later  issue  or  the  fact  that  the 
others  have  consented. 


PRIORITIES  OF  THE  OTHER  CREDITORS     327 

Where  such  consent  is  withheld,  the  conditions 
may  be  such  that  the  mortgage  may  be  foreclosed 
and  the  court  appoint  a  receiver  who  will  issue  his 
certificates  and  thus  raise  the  money  that  would  have 
been  forthcoming  if  the  issue  of  prior  lien  or  prefer- 
ential bonds  had  not  been  blocked.  These  certifi- 
cates may  be  given  a  prior  lien  over  the  mortgage. 
See  Receiver's  certificates.  Page  210. 

Extended  bonds  or  notes. 

In  the  reorganization  or  readjustment  of  a  rail- 
road company,  the  holders  of  its  outstanding  bonds 
or  notes  may  consent  to  extend  the  time  for  the  pay- 
ment of  their  securities.  This  is  usually  done  by 
surrendering  their  bonds  or  notes,  as  the  case  may 
be,  and  receiving  in  their  place  bonds  or  notes  of  a 
new  issue  with  the  extended  date  of  maturity. 

However,  instead  of  issuing  new  bonds  or  notes 
the  plan  may  be  that  the  old  ones  may  be  retained 
and  coupons  for  the  interest  of  the  additional  period 
issued.  When  this  is  done  and  there  is  any  other 
change  made  in  the  terms  of  the  original  bonds  or 
notes,  and  of  the  mortgage  if  they  are  secured,  such 
change  is  stamped  on  such  old  bonds  or  notes.  See 
Stamped  bonds.  Page  308. 

The  same  property  that  was  pledged  as  security 
for  the  original  bonds  or  notes  usually  remains  as 
security  for  the  new  issue;  though  a  different  ar- 
rangement may  at  that  time  be  made  on  consent. 


328  RAILROAD  BONDS  AND  NOTES 

The  extended  bonds  or  notes  are  sometimes  issued 
for  a  higher  rate  of  interest  to  induce  the  extension 
of  time;  or  security  or  additional  security  may  be 
given.  Sometimes  the  holders  of  such  bonds  or 
notes  may  consider  it  wise  to  accept  the  same  or  a 
lower  rate  of  interest  and  thus  help  out  the  road  at 
this  critical  period,  when  with  additional  time  re- 
quested it  may  adjust  its  affairs.  An  extension  of 
the  time  of  payment  may  release  the  guarantors. 
See  Guaranteed  bonds.  Page  293. 

Scaling. 

By  scaling  is  meant  a  reduction  of  the  indebted- 
ness of  the  road  by  the  consent  of  its  creditors.  In 
the  case  of  the  holders  of  bonds  or  notes,  each  gives 
up  a  proportionate  share  of  his  holdings. 

The  amount  of  the  outstanding  indebtedness  is 
reduced  by  the  holders  of  the  bonds  and  notes  sur- 
rendering their  holdings  and  receiving  in  exchange 
new  bonds  or  notes,  as  the  case  may  be,  for  the 
smaller  amount  and  releasing  the  railroad  company 
as  to  the  balance.  At  the  same  time  the  new  bonds 
or  notes  may  be  for  a  different  rate  of  interest,  or 
such  other  concessions  made  by  such  holders  as  the 
arrangement  for  the  scaling  may  contemplate.  The 
new  bonds  or  notes,  when  secured,  are  entitled  to 
the  same  rights  under  the  mortgage  that  secured  the 
surrendered  bonds  or  notes  as  the  latter  had  in  the 
absence  of  anything  to  the  contrary  agreed  upon  by 


PRIORITIES  OF  THE  OTHER  CREDITORS      329 

the  parties.  But  the  arrangement  under  which  the 
scaling  is  made  may  contain  some  other  arrangement 
which  will  disturb  the  lien  of  the  mortgage  or  the 
security  that  the  holders  had.  It  is  all  a  matter  of 
agreement  between  the  parties;  it  is  what  they  con- 
sent to.  The  holder  of  the  bond  or  note  that  is 
sought  to  be  scaled  is  not  affected  by  any  arrange- 
ment to  that  effect  unless  he  has  consented  to  it ;  the 
consent  of  the  other  holders  of  the  same  issue  cannot 
affect  his  rights  unless  he  has  given  them  the  power 
to  bind  them  as  in  the  case  where  he  has  consented 
to  be  bound  by  the  vote  of  a  majority  of  the  hold- 
ings of  that  issue. 

Income  bonds ;  debenture  income  bonds ;  mortgage 
income  bonds;  non-cumulative  income  bonds; 
cumulative  income  bonds;  assented  income 
bonds. 

Income  bonds  have  their  interest  secured  by  a 
mortgage  on  the  income  of  the  railroad  company. 
The  right  to  receive  any  interest  depends  upon  the 
fact  whether  or  not  sufficient  income  has  been  earned 
during  that  interest  period  to  pay  the  interest. 

If  the  railroad  company  does  not  earn  the  inter- 
est, the  holders  of  the  income  bonds  are  not  entitled 
to  it.  Its  non-payment  is  not  a  default:  as  its  pay- 
ment is  made  dependent  upon  whether  or  not  it  is 
earned. 

The   interest  only  is   usually  secured;   and   the 


330  RAILROAD  BONDS  AND  NOTES 

security  is  not  any  tangible  property  of  the  road  but 
is  limited  to  the  income  only.  The  principal  of  in- 
come bonds  may  or  may  not  be  secured  by  mortgage 
on  tangible  property  of  the  railroad  company. 

If  the  principal  be  not  secured,  then  the  holder  of 
the  income  bonds,  so  far  as  its  principal  is  concerned, 
is  a  general  or  unsecured  creditor.  They  are  then 
sometimes  called  "debenture"  income  bonds.  See 
Secured  and  unsecured  creditors.  Page  227.  See 
also  Debenture  bonds.  Page  1 1 . 

If  the  principal  of  the  income  bonds  is  secured  by 
a  mortgage  on  the  property  of  the  railroad  company, 
then  the  right  of  the  holders  of  such  bonds  are  the 
same  under  it  as  those  of  other  bonds  secured  by  rail- 
road mortgages;  that  is,  their  priority  and  rank 
among  the  other  incumbrances  against  the  property 
depend  upon  the  terms  and  conditions  of  the  bonds 
and  mortgage  and  the  time  when  its  lien  attached  to 
the  property  in  question. 

The  income  that  is  pledged  to  the  payment  of  the 
interest  of  the  income  bonds  is  usually  the  net  in- 
come arising  from  the  operation  of  the  road  and  its 
appurtenances ;  though  the  income  may  be  limited  to 
that  from  a  certain  source. 

The  rate  of  interest  is  fixed.  The  interest  is  pay- 
able semi-annually,  as  a  rule. 

The  income  that  is  pledged  to  the  payment  of 
each  instalment  of  interest,  as  a  rule,  is  that  which 
has  been  earned  during  that  interest  period  only. 


PRIORITIES  OF  THE  OTHER  CREDITORS     331 

Should  there  not  be  sufficient  to  pay  all  the  interest 
of  the  income  bonds  for  that  period  in  full,  then 
those  entitled  to  such  interest  are  paid  proportion- 
ately out  of  the  income  of  that  period  only.  The 
entire  interest,  or  any  portion  thereof,  as  the  case 
may  be,  of  a  certain  interest  period  may  be  lost  if 
not  earned  during  that  same  period.  Such  is  the 
non-cumulative  income  bond. 

The  cumulative  income  bond  provides  otherwise. 
Those  entitled  to  the  interest  of  the  cumulative  in- 
come bond  are  entitled  to  have  any  deficit  or  loss  of 
interest  in  any  past  period  carried  forward  and  paid 
out  of  future  interest  periods  until  all  arrearages  of 
interest  have  been  paid  in  full. 

These  arrearages  thus  carried  forward  and 
charged  on  succeeding  interest  periods  have  no  better 
rights  than  the  interest  charges  of  such  later  periods 
and  are  paid  only  out  of  the  net  income  of  such 
future  periods  after  all  prior  charges. 

Whether  the  income  bond  is  cumulative  or  non- 
cumulative  is  stated  on  its  face  or  in  the  mortgage 
securing  it ;  should  nothing  be  said  on  this  point  then 
the  bond  is  non-cumulative  and  any  loss  of  interest 
during  one  interest  period  is  not  carried  forward  and 
is  not  made  a  charge  on  succeeding  interest  periods, 
but  is  lost  to  the  one  entitled  thereto. 

Income,  when  the  term  is  used  with  relation  to 
income  bonds,  means  net  income  or  net  earnings. 

Ordinarily,  the  net  income  of  a  railroad  is  the  dif- 


332  RAILROAD  BONDS  AND  NOTES 

ference  between  the  gross  earnings  and  the  expendi- 
tures incurred  in  producing  them.  It  is  what  is  left 
after  paying  the  expenses  of  producing  the  income, 
including  the  fixed  charges. 

What  shall  constitute  income  is  often  agreed  upon 
in  the  bonds  and  the  mortgage,  and  the  mode  of 
ascertaining  it  is  regulated  there  also. 

The  bond  or  the  mortgage  may  limit  the  income 
to  be  paid  for  interest  on  the  income  bonds  to  the 
income  produced  from  certain  specified  sources,  such 
as,  from  specified  branch  lines  or  divisions  of  the 
system,  or  it  may  embrace  the  income  produced  from 
all  sources  including  that  earned  in  the  operation  of 
all  the  lines  and  other  property  then  owned  by  the 
railroad  company  making  the  issue  and,  in  addition, 
from  all  that  may  be  acquired  at  any  time  during  the 
life  of  the  mortgage. 

The  board  of  directors  of  a  railroad  company 
have  a  wide  discretion  in  determining  what  shall  be 
treated  as  income,  in  the  absence  of  anything  in  the 
bond  or  the  mortgage  limiting  their  powers  in  that 
respect.  The  personnel  of  the  board  of  directors 
is  therefore  an  important  factor  to  be  considered,  and 
it  is  worthy  of  attention  that  they  shall  not  use 
monies  that  should  go  to  the  payment  of  interest  on 
income  bonds,  to  make  betterments  that  enhance  the 
value  of  the  property  beyond  mere  repairs,  improve- 
ments, or  extensions  when  they  are  not  necessary. 

The  railroad  company  owes  the  duty  to  the  hold- 


PRIORITIES  OF  THE  OTHER  CREDITORS      333 

ers  of  the  income  bonds  to  keep  books  of  account  of 
their  earnings  and  expenses  of  the  mortgaged  road 
and  the  other  property  from  which  the  income 
pledged  to  them  is  to  be  derived,  so  that  they  can 
readily  see  what  the  net  income  is.  And  the  trus- 
tee under  the  mortgage  securing  the  income  bonds, 
when  there  is  a  mortgage  securing  them,  owes  the 
active  duty  to  his  bondholders  to  supervise  the  ac- 
counts and  see  that  their  rights  are  properly  re- 
garded. 

The  accounts  should  show  the  net  income  for  each 
interest  period.  Where  several  lines  or  divisions 
of  the  road  are  separately  mortgaged,  the  duty  is 
then  imposed  on  the  railroad  company  to  keep  sep- 
arate accounts  as  to  each.  And  the  holders  of  the 
income  bonds  issued  against  the  income  of  one  line 
or  division  have  the  right  to  insist  that  expenditures 
chargeable  to  another  shall  not  be  charged  against 
the  income  mortgaged  to  them. 

The  gross  earnings  of  a  period  shall  bear  only  the 
expenses  incurred  in  producing  it  and  the  fixed 
charges  of  the  railroad  company  for  that  period. 
And  the  holders  of  non-cumulative  income  bonds 
are  entitled  to  insist  that  a  special  or  unusually  large 
amount  which  fell  due  and  was  paid  and  was 
charged  in  any  one  interest  period  to  their  loss  of 
interest,  shall  be  apportioned  among  other  interest 
periods  and  adjusted  with  a  view  to  v/hat  is  fair  to 
the  interests  of  all  concerned. 


334  RAILROAD  BONDS  AND  NOTES 

When  the  affairs  of  a  railroad  company  are  af- 
fected by  leasing  or  consolidation  or  merger,  there 
is  the  likelihood  that  the  standing  of  the  income 
bonds  may  be  changed.  They  are  then  sometimes 
guaranteed  as  to  principal  or  interest,  or  both,  by  the 
new  corporation,  or  the  new  system  or  some  of  its 
members,  resulting  from  such  consolidation  or 
merger,  or  by  the  main  01  parent  company  which  is 
a  party  to  the  lease.  Or  an  arrangement  may  be 
substituted  whereby  a  regular  stipulated  interest 
shall  be  paid  and  regarded  as  a  fixed  charge,  to  be 
paid  on  designated  interest  days.  The  interest 
thereafter  is  not  dependent  upon  the  earnings  of  in- 
come as  was  originally  agreed  upon  but  is  a  fixed 
charge. 

When  such  changes  are  made  in  the  income  bonds, 
they  are  noted  on  the  bonds  themselves,  and  they 
are  then  known  as  "assented"  income  bonds;  or  the 
old  issue  may  be  surrendered  and  other  bonds  con- 
taining the  changes  are  received  in  exchange.  See 
Assented  bonds.  Page  325. 


CHAPTER  VIII 

RIGHTS    AND    REMEDIES    WITH    RELATION    TO    THE 
REORGANIZATION    OF    THE    RAILROAD    COMPANY 

Different  forms  of  reorganization;  new  charter; 
sale  or  lease  of  property;  consolidation  or 
merger;  by  assessment  of  stockholders;  bond- 
holders waiving  lien  and  accepting  new  securi- 
ties; scaling;  new  management. 

A  reorganization  of  a  railroad  company,  using  the 
term  broadly,  is  a  readjustment  of  its  affairs. 

To  proceed  under  a  new  charter  after  the  time 
limited  in  the  original  one  has  expired,  or  where  the 
original  charter  has  been  lost  by  forfeiture  or  dis- 
solution of  the  railroad  company,  has  been  regarded, 
in  this  broad  sense,  as  a  reorganization. 

The  lease  or  sale  of  all  or  nearly  all  of  the  prop- 
erty of  a  railroad  to  another  is  in  effect,  quite  gen- 
erally, a  reorganization  of  its  affairs. 

A  reorganization  results  from  the  consolidation  of 
one  railroad  with  or  its  merger  into  one  or  more  other 
railroad  corporations  or  a  system. 

Other  methods  by  which  the  affairs  of  an  em- 
barrassed railroad  company  are  rearranged  are  called 
reorganizations  that  may  be  termed,  more  properly, 

335 


336  RAILROAD  BONDS  AND  NOTES 

readjustments.  For  instance,  the  insolvency  of  the 
road  and  imminent  foreclosure  may  be  brought 
about  because  its  earning  capacity  is  limited,  princi- 
pally on  account  of  lack  of  funds  with  which  to  pro- 
vide adequate  equipment  and  improvements  neces- 
sary to  develop  its  possibilities  and  enable  its  busi- 
ness to  be  handled  with  economy  and  profit.  The 
funds  necessary  for  this  purpose  are  sometimes  raised 
by  assessing  the  stockholders.  With  the  money  so 
provided,  interest  due  on  the  bonded  indebtedness  is 
paid,  the  road  is  equipped  and  put  in  a  profit  earning 
condition,  restored  to  solvency,  and  a  foreclosure 
avoided.  However,  should  the  stockholders  refuse 
to  pay  the  necessary  assessment,  then  the  bondhold- 
ers foreclose  their  mortgage  and  ask  the  court  to  ap- 
point a  receiver,  which  is  usually  done.  Under 
order  of  the  court,  receiver's  certificates  are  issued 
and  sold  to  raise  the  money  with  which  to  meet  neces- 
sary requirements,  and  the  road  is  thus  continued  in 
operation,  and  in  time  put  in  a  profit  earning  con- 
dition. The  proposition  is  then  submitted  to  the 
stockholders  that  they  supply  the  necessary  money, 
to  be  raised  by  pro  rata  assessment  among  themselves, 
with  which  to  pay  off  these  certificates  and  the  ex- 
penses of  the  receivership,  and  take  back  the  road  in 
its  profit  earning  and  readjusted  condition.  Should 
the  stockholders  not  do  so  then  the  foreclosure  pro- 
ceeds to  a  sale  of  the  mortgaged  road. 

Sometimes  the  secured  bondholders  come  to  the 


337 

aid  of  the  insolvent  road — which  may  be  only  tem- 
porarily embarrassed — and  extend  the  time  for  the 
payment  of  their  bonds  or  arrange  about  the  interest. 
See  Extended  bonds.  Page  327.  Or  they  may 
waive  the  lien  of  their  mortgage  in  favor  of 
those  lending  money  to  the  company  at  this  critical 
time.  See  Prior  lien  bonds;  preferential  bonds. 
Page  326.  This  is  done  by  such  bondholders  con- 
senting that  a  new  issue  of  bonds  for  a  specified 
amount  be  issued  and  that  it  shall  be  secured  by  a 
mortgage  on  the  property  of  the  road  which  shall  be 
entitled  to  priority  in  payment  out  of  the  mortgaged 
property  over  their  mortgage;  or  they  may  consent 
that  the  holders  of  the  new  issue  of  bonds  shall 
share  with  them  equally  in  the  security  their  mort- 
gage gives  them.  These  latter  arrangements  are  ac- 
complished by  such  bondholders  surrendering  their 
bonds  and  taking  in  exchange  others  under  the  new 
mortgage,  which  is  issued  for  an  amount  that  will 
cover  the  bonds  to  be  surrendered  and  the  bonds  for 
the  money  to  be  raised.  With  the  surplus  so  raised 
the  road  is  relieved  from  the  embarrassments  that 
pressed  it  and  resumes  profitable  operation.  Or  the 
bondholders  may  exchange  their  interest  bearing 
bonds  for  income  bonds,  thus  reducing  the  fixed 
charges  and  making  the  payment  of  interest  depend- 
ent upon  the  fact  that  it  has  been  earned.  See  In- 
come bonds.  Page  329. 

Again,  should  the  creditors  and  the  stockholders 


338  RAILROAD  BONDS  AND  NOTES 

be  willing,  the  affairs  of  the  company  may  be  placed 
upon  a  better  footing  by  all  consenting  to  give  up 
part  of  their  bonds,  notes,  claims,  or  stock,  and  thus 
reducing  fixed  charges  relieve  the  company  of  the 
burdens,  or  some  of  them,  that  interfered  with  its 
profitable  operation.  This  is  called  scaling.  Each 
scales  down  his  demands  or  rights  proportionately. 
To  carry  out  a  readjustment  of  this  kind  the  consent 
of  those  participating  must  be  obtained.  Those 
who  do  not  consent  occupy  their  original  positions: 
the  arrangement  cannot  be  forced  upon  them. 
Should  the  holders  of  a  large  amount  of  the  securi- 
ties or  claims  sought  to  be  scaled  object,  it  renders 
the  plan  inoperative  and  a  foreclosure  and  a  receiver- 
ship are  likely  to  follow.  The  objection  of  the 
holders  of  a  small  amount  may  be  overcome  by  pur- 
chasing their  securities.  See  Scaling.  Page  328. 

Where  the  management  of  the  road  has  been  in- 
competent, inefficient,  or  influenced  by  conflicting 
interests  or  improper  motives,  a  radical  and  complete 
change  in  this  respect  is  also  a  kind  of  readjustment 
or  reorganization. 

Outline  of  procedure  in  reorganization. 

When  the  trustee  forecloses  the  mortgage  or 
during  the  period  when  the  affairs  of  the  company 
have  reached  the  crisis  that  makes  reorganization 
expedient,  the  holders  of  the  obligations  of  a  railroad 
company  and  others  financially  interested  in  its 


REORGANIZATION  OF  THE  RAILROAD      339 

affairs  usually  come  together,  form  an  agreement 
among  themselves  and  formulate  and  work  out  a 
plan  by  which  the  road  is  purchased,  is  put  in  as  good 
physical  and  financial  condition  as  the  circumstances 
reasonably  warrant,  and  is  continued  in  operation. 

The  initiative  is  taken  usually  by  the  holders  of 
the  larger  blocks  of  the  securities  or  by  a  leading 
banking  house. 

The  course  pursued  is  for  a  number  of  men 
well  known  in  the  financial  world,  to  form 
themselves  into  a  committee  which  prepares  and 
submits  an  agreement  for  reorganization,  in  which 
it  is  arranged  that  the  bondholders  and  others 
participating  shall  deposit  their  securities  with  the 
depositary  that  is  named  (usually  a  trust  company) 
and  that  thereupon  they  shall  become  parties  to  the 
agreement.  These  agreements  are  interchangeably 
called  "reorganization  agreements,"  "bondholders' 
agreements,"  or  "agreements  of  deposit."  By  what- 
ever name  called,  they  are  agreements  under  which 
the  parties  financially  interested  in  the  affairs  of  the 
embarrassed  railroad  attempt  to  reorganize  it.  The 
agreement  contains  the  duties  and  rights  of  the  com- 
mittee and  of  those  who  become  parties  to  it. 
Pursuant  to  this  agreement  a  plan  is  adopted  by 
which  it  is  usually  arranged  that  the  road  shall  be 
purchased  at  the  foreclosure  sale  or  otherwise,  by  the 
committee,  as  the  representative  of  the  parties  to 
the  agreement.  When  the  road  is  thus  purchased 


340  RAILROAD  BONDS  AND  NOTES 

it  is  turned  over  to  a  new  corporation.  This  new 
corporation  takes  the  property  thus  conveyed  to  it, 
generally  speaking,  free  from  the  debts  of  the  old 
company,  and  proceeds  to  operate  it  under  new 
management  and  relieved  from  many  of  the  burdens 
that  hampered  the  old  company.  The  property  is 
purchased  with  the  bonds  or  other  securities  that 
have  been  deposited  under  the  agreement,  together 
with  such  assessments  that  may  have  been  levied  or 
monies  raised  by  other  means  under  the  reorganiza- 
tion agreement  or  the  plan.  The  securities  of  the 
new  corporation  are  issued  to  those  participating  in 
the  reorganization,  to  represent  their  interests  in  the 
property  purchased.  The  new  corporation  is 
financed  by  selling  its  capital  stock,  by  issuing  its 
bonds  or  notes,  and  by  obtaining  credit. 

Attitude  of  courts  toward  reorganizations;  pro- 
posed reorganization  must  be  fair. 

The  courts  recognize  that  large  sums  of  money 
are  necessary  to  purchase  railroad  property  at  fore- 
closure sales,  and  therefore  favor  those  means  by 
which  holders  of  the  bonds  and  other  obligations  of 
the  road  may  unite  their  securities  and  make  a  bid 
large  enough  to  protect  the  property  from  sacrifice. 
By  thus  combining  their  securities,  these  holders  are 
able  to  make  a  purchase  which  separately  they  could 
not. 

The  law  condemns  a  reorganization  that  is  merely 


REORGANIZATION  OF  THE  RAILROAD     341 

a  guise  for  stifling  competition  in  bidding;  and  the 
courts  will  stop  such  an  attempt  by  injunction,  and 
set  the  transfer  aside  if  it  is  carried  out. 

That  the  holders  of  the  outstanding  obligations 
of  the  company,  or  a  portion  of  them,  have  united 
for  the  purpose  of  purchasing  the  property  of  the 
road  does  not  preclude  others  from  bidding  at  the 
sale. 

Courts  favor  reorganizations  when  proper  as  they 
save  a  probable  sacrifice  of  the  security,  for  the  far 
greater  value  of  railroad  property  lies  not  in  its  in- 
trinsic value  as  property,  but  in  its  cohesive  use  and 
operation  as  a  railroad.  And,  too,  the  reorganiza- 
tion of  the  road  continues  it  in  operation,  thus  en- 
abling it  to  serve  the  public  and  to  discharge  its 
obligations  in  that  regard. 

The  agreement  and  the  plan  for  the  reorganiza- 
tion must  be  fair.  Should  it  be,  in  any  way,  fraudu- 
lent or  oppressive  to  a  minority,  no  matter  how 
small,  of  the  parties  participating,  the  court  will 
protect  those  against  whom  it  unfairly  operates  and 
may  prevent  a  reorganization  from  being  carried 
out,  or  otherwise  provide  for  them.  Courts  will  not 
allow  a  majority,  no  matter  how  large,  of  the  hold- 
ers of  the  securities  of  the  road,  nor  any  set  of  them, 
to  gain  any  advantage  over  their  associates  through 
the  means  of  a  reorganization. 

The  legislatures  of  nearly  all  the  states  have  en- 
acted laws  aiding  the  purchasers  of  the  franchise 


342  RAILROAD  BONDS  AND  NOTES 

and  the  property  of  a  railroad  corporation  at  a  fore- 
closure sale  to  form  a  new  corporation  to  continue 
the  road  in  operation. 

Rights  of  bondholders,  generally,  to  participate  in 
the  reorganization;  to  receive  notice  and  op- 
portunity to  examine  proposed  agreement  for 
reorganization. 

Each  bondholder  has  an  equal  right  to  participate 
in  any  reorganization  or  proper  combination  by  the 
other  bondholders  under  the  same  mortgage  to  pur- 
chase the  property  of  the  road.  The  law  will  not 
permit  any  discrimination  to  be  made  against  any 
bondholder  of  the  same  issue.  All  have  a  common 
interest  in  the  security.  Each  has  rights  equal  to 
the  rights  of  those  attempting  the  reorganization. 
All  must  have  an  equal  opportunity  to  come  in  and 
share  in  the  benefits  of  any  reorganization  and  pro- 
tect their  security. 

Each  bondholder  entitled  to  join  in  the  reorgan- 
ization must  be  given  a  fair  opportunity  to  do  so 
and  to  become  acquainted  with  the  terms  of  the  pro- 
posed agreement  for  reorganization.  He  is  entitled 
to  a  reasonable  notice  (usually  by  publication  in 
the  newspapers)  of  the  terms  of  the  agreement,  or  of 
the  fact  of  its  preparation  and  filing  and  where  he 
may  examine  it.  After  this  he  must  have  a  fair  op- 
portunity to  decide  whether  or  not  he  wishes  to  be- 
come a  party  to  the  agreement  and  participate  in 


REORGANIZATION  OF  THE  RAILROAD      343 

the  reorganization  it  contemplates.  Printed  copies 
of  the  agreement  are  usually  furnished  by  the  de- 
positary on  application. 

Rights  of  bondholders  who  do  not  join  in  the  reor- 
ganization; rights  upon  withdrawal  from 
agreement  or  abandonment  of  reorganization ; 
reorganization  by  majority  against  objections 
of  minority ;  provisions  in  mortgage  empower- 
ing majority ;  interest  of  minority  protected  by 
the  courts. 

A  bondholder  may  refuse  to  join  in  the  agreement 
or  the  plan  for  reorganization.  He  cannot  be  com- 
pelled to  join  as  the  enterprise  of  the  new  corpora- 
tion that  is  contemplated  cannot  be  forced  upon  him 
unless,  by  the  terms  of  the  mortgage  securing  his 
bond,  he  has  agreed  to  be  a  party  to  the  reorganiza- 
tion proceedings  commenced  under  it  by  the  holders 
of  a  majority  (or  other  designated  proportion)  in 
amount  of  the  outstanding  bonds  of  that  issue. 

A  bondholder  is  entitled  to  stand  upon  his  orig- 
inal rights  and  to  receive  his  proportionate  share  of 
the  proceeds  of  the  sale  of  the  property  that  was 
mortgaged  or  pledged  to  secure  the  issue  of  bonds  of 
which  he  holds.  His  rights  in  this  respect  cannot 
be  affected,  in  any  way,  by  a  reorganization  to  which 
he  is  not  a  party. 

One  who  was  a  party  to  a  reorganization  agree- 
ment, but  has  withdrawn  from  it,  stands  upon 


344  RAILROAD  BONDS  AND  NOTES 

the  same  footing  as  he  did  before  he  became  a  party 
to  such  agreement,  and  is  entitled  to  his  proportion- 
ate share  of  the  proceeds  of  the  sale  of  the  property 
that  was  mortgaged  or  pledged  to  secure  the  issue  of 
which  he  holds.  And  when  a  reorganization  is 
abandoned,  in  the  absence  of  anything  agreed  upon 
to  the  contrary,  the  rights  of  the  parties  are  the  same 
as  if  no  reorganization  had  been  attempted :  that  is, 
each  is  entitled  to  his  proportionate  share  of  the 
proceeds  of  the  sale  of  the  property  that  was  mort- 
gaged or  pledged  to  secure  the  issue  of  which  he 
holds.  When  an  attempted  reorganization  is  dis- 
solved or  abandoned  it  is  invariably  only  under  some 
arrangement  whereby  its  parties  shall  pay  propor- 
tionately certain  specific  expenses  or  advances  and 
bear  obligations  already  incurred. 

In  some  railroad  mortgages  a  provision  is  con- 
tained that  the  holders  of  a  majority,  in  amount  of 
the  obligations  it  secures,  shall  have  the  power  to 
reorganize  the  road  upon  its  default  and  insolvency. 
A  majority  of  a  specified  proportion  may  be  men- 
tioned. The  majority,  or  the  requisite  majority, 
under  such  a  provision,  formulate  their  reorganiza- 
tion agreement  and  plan,  and  it  is  binding  on  the 
minority.  The  minority  under  these  circumstances 
will  not  be  heard  to  object  because  it  has  consented 
to  be  bound  by  the  act  of  such  majority,  in  this  re- 
gard, when  it  accepted  its  bonds  under  the  mortgage 
containing  this  provision.  But  the  majority  must 


REORGANIZATION  OF  THE  RAILROAD      345 

exercise  this  power  in  good  faith.  Should  it  abuse 
it  and  act  fraudulently  or  oppressively,  the  minority 
will  not  be  bound  by  its  acts. 

And  even  though  there  be  no  such  provision  in 
the  mortgage  giving  the  majority  the  power  to  re- 
organize and  bind  the  minority  by  its  acts,  or  of  any 
statute  to  the  same  effect,  the  courts  will  not  permit 
a  small  minority,  representing  a  comparatively  in- 
significant amount  of  the  outstanding  bonds,  to  de- 
feat the  wishes  of  an  overwhelming  majority  in 
amount,  when  there  is  no  pretense  of  fraud  or  unfair- 
ness in  what  the  latter  propose  doing.  The  action 
of  the  courts  in  this  regard  is  based  upon  the  con- 
clusion that  the  public  obligation  that  the  railroad 
company  owes  to  continue  the  road  in  operation,  is 
superior  to  the  private  property  rights  of  such  mi- 
nority; and,  therefore,  under  the  circumstances  men- 
tioned, will  assist  in  carrying  out  a  railroad  reorgan- 
ization against  the  objections  of  a  small  minority, 
in  amount,  of  bondholders. 

When  the  reorganization  is  thus  carried  through 
against  the  objections  of  a  minority,  the  court  will 
see  that  such  minority  is  fairly  treated  and  its  inter- 
ests fully  protected.  The  provisions  for  the  object- 
ing minority  depend  entirely  upon  the  facts  and 
circumstances  of  each  particular  case  before  the 
court.  The  precedents  show  that  the  courts  have 
ordered  that  the  bonds  of  the  minority  be  taken 
care  of  by  deposit  of  the  money  due  with  the  court, 


346  RAILROAD  BONDS  AND  NOTES 

or   by   an   indemnity   bond,    to   secure   their   pay- 
ment. 

Bondholders  may  reorganize  alone;  or  with  other 
creditors,  or  with  the  stockholders,  or  with 
both;  interests  of  unsecured  creditors  pro- 
tected ;  rights  of  stockholders  of  insolvent  com- 
pany; terms  upon  which  they  may  acquire 
rights  in  new  company. 

It  has  been  found  expedient,  at  times,  that  the 
bondholders,  secured  by  the  foreclosed  mortgage, 
should  ask  other  creditors  of  the  insolvent  company 
or  its  stockholders,  or  both,  to  join  them  in  a  pro- 
posed reorganization,  and  share  in  the  new  corpora- 
tion according  to  their  respective  rights,  as  well  as 
the  same  can  be  adjusted.  This  is  to  avoid  the  em- 
barrassment and  delay  that  such  other  creditors  and 
stockholders  may  cause  to  a  reorganization  conducted 
exclusively  by  the  bondholders  under  the  foreclosed 
mortgage;  and,  as  the  stockholders  usually  pay  in 
cash  for  such  stock  of  the  new  corporation  that  they 
get,  the  money  thus  raised  is  a  timely  aid  to  the  new 
corporation  and  helps  along  the  reorganization. 

The  bondholders  under  the  foreclosed  mortgage 
and  the  stockholders  may  unite  for  the  purpose  of 
reorganizing;  but  such  a  combination  must  not  be 
for  any  fraudulent  purpose.  And  where  unsecured 
creditors  show  that  the  purchase  and  reorganization 
by  the  bondholders  in  combination  with  the  stock- 


REORGANIZATION  OF  THE  RAILROAD     347 

holders  (or  a  reorganization  by  the  stockholders 
alone)  is  for  the  purpose  of  destroying  their  inter- 
ests, they  are  entitled  to  have  all  proceedings  stayed 
until  the  matter  has  been  fully  examined  into  and 
their  interests  accorded  a  proper  protection;  if  the 
property  has  been  already  purchased  and  taken  over, 
they  may  follow  it  into  the  possession  of  the  new 
corporation  and  the  courts  will  enforce  their  rights 
against  it. 

Stockholders  of  the  old  corporation  have  no  right 
to  any  of  its  property  until  every  creditor  has  been 
paid  in  full ;  and  if  by  any  plan  of  reorganization,  or 
otherwise,  they  attempt  to  take  to  themselves  prop- 
erty of  the  road  before  every  creditor  has  been  paid 
in  full,  it  is  a  fraud  on  such  unpaid  creditors  who 
may  enforce  their  claims,  according  to  their  respec- 
tive ranks,  against  such  property  that  the  stock- 
holders have  thus  wrongfully  taken  to  themselves. 

A  stockholder  is  entitled  to  his  proportionate  share 
of  the  assets  of  the  corporation  after  every  debt  has 
been  paid  in  full  and  every  obligation  has  been  fully 
discharged.  The  ownership  of  stock  in  an  insolvent 
corporation  carries  with  it  no  rights  in  its  assets. 
If  the  company  be  insolvent,  it  has  not  sufficient 
assets  to  pay  all  its  creditors,  and,  therefore,  it  owns 
nothing  itself,  and  its  stock  cannot  represent  any- 
thing. And  stockholders  in  an  insolvent  railroad 
company  can  acquire  no  rights  in  the  new  corpora- 
tion by  reason  of  their  ownership  of  stock  in  the  old 


348  RAILROAD  BONDS  AND  NOTES 

company;  they  must  pay  for  any  rights  in  the  new 
company  with  money  or  property. 

However,  that  one  is  a  stockholder  in  the  in- 
solvent railroad  company  is  no  objection  to  his  par- 
ticipating in  the  reorganization  independently  of  his 
ownership  of  stock;  for  he  may  be  also  a  bondholder 
or  other  creditor  of  the  road,  or  he  may  pay  for 
whatever  interest  in  the  new  company  that  he  may 
acquire. 

As  the  foreclosure  sale  of  the  property  of  the  in- 
solvent company  cuts  off  all  rights  of  its  stockholders 
in  the  property  sold,  they  can  have  no  rights  in  the 
property  taken  over  by  the  nev  corporation,  and  can 
have  only  such  rights  in  the  new  corporation  or  its 
property  as  the  reorganization  agreement  or  the 
plan  gives  them.  And  it  is  quite  proper  for  the 
agreement  or  the  plan  to  make  provision  for  the 
stockholders.  These  provisions  are  usually  to  the 
effect  that  the  stockholders  may  obtain  stock  in  the 
new  corporation  by  surrendering  their  old  stock  and 
paying  a  specified  sum  for  the  new  stock.  The 
agreement  or  the  plan  may  leave  it  to  the  committee 
to  fix  this  amount.  The  committee  must  render  an 
accounting  of  expenses  and  indebtednesses  showing 
the  financial  condition  that  exists,  and  revealing  the 
computation  upon  which  it  bases  the  amount  of  this 
assessment,  so  that  they  (the  stockholders)  may 
have  an  opportunity  to  examine  into  the  matter,  and 
call  upon  the  court  to  protect  them  should  the  as- 


REORGANIZATION  OF  THE  RAILROAD     349 

sessment  be  unfair  or  improper.  However,  in  the 
absence  of  fraud  or  unreasonable  conduct  in  fixing 
this  amount,  the  court  will  not  interfere  with  the 
action  of  the  committee. 

Synopsis  of  reorganization  agreement. 

The  agreements  by  which  the  reorganization  of  a 
railroad  company  is  attempted  to  be  worked  out  are 
variously  known  as  "reorganization  agreements," 
"depositors'  agreements,"  or  "bondholders'  agree- 
ments." 

This  agreement  is  made  between  the  committee, 
the  bondholders  under  the  foreclosed  mortgage  and 
such  others  as  shall  join  in  with  them.  The  depos- 
itary is  also  sometimes  made  a  party. 

A  reorganization  agreement  is  a  contract  between 
the  parties  to  it.  It  appoints  the  committee  which 
shall  represent  the  bondholders  and  the  other  parties 
to  it,  in  the  reorganization  proceedings.  It  usually 
provides  that  the  parties  shall  deposit  their  bonds 
or  other  securities,  and  gives  in  detail  the  rights  and 
obligations  of  those  who  become  parties  to  it.  The 
powers  and  duties  of  the  committee  with  relation 
to  such  deposited  securities  and  such  other  property 
as  it  may  acquire  in  the  course  of  the  reorganization 
are  specified.  It  provides  for  the  preparation  and 
adoption  of  the  plan  (which  is  usually  a  separate 
document)  by  which  the  property  of  the  road  shall 
be  purchased,  the  new  corporation  formed,  and 


350  RAILROAD  BONDS  AND  NOTES 

property  conveyed  to  it.  It  sets  forth  the  rights  of 
all  the  participating  parties  in  such  new  corporation. 
The  agreement  or  the  plan  may  also  provide  for 
further  powers  in  the  committee,  such  as  making 
changes  in  the  agreement  or  the  plan,  extending  the 
time  within  which  the  securities  shall  be  deposited, 
and  extending  the  time  within  which  the  plan  shall 
be  consented  to  or  objected  to.  Provisions  may  be 
contained  also,  either  in  the  agreement  or  in  the  plan, 
as  to  the  expenses  and  compensation  of  the  commit- 
tee, and  how  such  committee  shall  be  constituted 
when  its  membership  is  depleted  by  resignation^ 
death,  or  otherwise.  The  agreement  or  the  plan  may 
provide  for  assessments  to  be  charged  against  the 
bondholders  and  others  participating  in  the  reorgan- 
ization. 

In  most  of  the  States  there  are  statutes  relating  to 
reorganization  of  railroad  corporations;  and  when 
this  is  the  case,  the  provisions  of  such  statutes  are 
part  of  the  reorganization  agreement  and  the  plan, 
and  the  parties  are  bound  by  them  with  the  same 
force  and  effect  as  if  they  were  set  out  in  the  agree- 
ment or  the  plan  at  length  and  in  detail. 

Becoming  a  party  to  the  agreement ;  by  signing ;  by 
deposit  of  securities;  limitation  of  period;  ex- 
tension of  period;  penalty. 

The  agreement  states  the  manner  in  which  the 
bondholder  shall  become  a  party  to  it.  Some  pro- 


REORGANIZATION  OF  THE  RAILROAD     351 

vide,  though  rarely,  that  one  may  become  a  party  to 
it  by  signing  his  name  thereto.  Most  agreements, 
however,  declare  that  one  shall  become  a  party  to 
them  by  depositing  the  specified  securities  held  by 
him  against  the  insolvent  corporation  with  the  de- 
positary. The  act  of  depositing  and  the  acceptance 
of  the  certificate  of  deposit,  issued  by  the  depositary, 
signify  a  consent  to  the  agreement  and  its  terms,  and 
the  depositor  then  becomes  a  party  to  it  with  the  same 
effect  as  if  he  had  subscribed  his  name  to  such  agree- 
ment. When  the  bondholder  deposits  his  bonds  he 
receives  a  certificate  of  deposit  from  the  depositary, 
which  represents  the  securities  deposited  by  him. 
See  Certificate  of  deposit.  Page  353. 

Usually  the  time  within  which  one  may  become 
a  party,  in  any  of  the  ways  mentioned,  is  limited. 
The  time  may  be  extended  by  the  committee  or  by 
the  court.  To  have  the  time  thus  extended  is  not 
an  absolute  right  that  the  bondholder  may  insist 
upon;  it  rests  with  the  committee  whether  or  not 
the  time  shall  be  extended.  However,  the  courts 
seem  disposed,  judging  from  the  trend  of  decisions, 
to  permit  bondholders  an  opportunity  to  come  in 
and  share  in  the  reorganization  upon  such  terms  as 
shall  be  fair  to  all  the  parties,  up  to  the  time  of  the 
foreclosure  sale  and  in  some  instances  thereafter. 

As  a  condition  for  the  privilege  of  coming  in  after 
the  time  has  expired,  the  court  or  the  committee, 
whichever  grants  the  privilege,  may  impose  a  pen- 


352  RAILROAD  BONDS  AND  NOTES 

alty.  The  amount  of  the  penalty  imposed  on  each 
bond  usually  does  not  exceed  one  per  centum  of  its 
face  amount. 

And  extension  of  the  time  within  which  the  bonds 
may  be  deposited  after  the  time  limit  has  expired 
may  be  conferred  on  all  bondholders  generally  or  in 
specific  cases  only. 

After  one  has  become  a  party  to  the  agreement, 
in  order  to  continue  as  such  party  and  enjoy  its  bene- 
fits, one  must  comply  with  all  its  requirements  as  to 
assenting  to  or  dissenting  from  the  plans  submitted, 
paying  assessments,  and  meeting  all  other  conditions 
it  may  contain. 

Use  of  deposited  bonds;  how  bonds  deposited. 

The  requirement  that  bondholders  in  order  to  be- 
come parties  to  the  agreement  for  reorganization 
shall  deposit  their  bonds  with  the  depositary  serves 
a  double  purpose,  for  in  addition  to  signifying  the 
intention  to  join  the  agreement,  it  places  the  bonds 
in  the  control  of  the  committee  to  use  them  to  pur- 
chase the  property  of  the  road  and  also  for  the  other 
purposes  of  the  reorganization. 

The  committee  holds  the  deposited  bonds  in  trust 
for  the  purposes  of  the  reorganization.  It  may  use 
them  only  in  strict  accordance  with  the  terms  of  the 
agreement  under  which  they  were  deposited.  The 
agreement  usually  authorizes  the  committee  to  use 
and  dispose  of  the  deposited  bonds  to  purchase  the 


REORGANIZATION  OF  THE  RAILROAD     353 

property  of  the  insolvent  road,  and  for  any  other 
purpose  which  in  its  judgment  it  believes  necessary 
to  carry  out  the  reorganization. 

Coupon  bonds  are  deposited  with  all  unpaid  cou- 
pons attached,  that  is,  coupons  that  have  matured 
and  have  not  been  paid  and  those  not  yet  matured. 

Registered  bonds  are  deposited  with  such  trans- 
fers, assignments,  powers  of  attorney,  or  proxies, 
invariably  in  blank,  as  will  pass  a  full  title  to  such 
bonds  to  the  committee  and  enable  it  to  use  them  for 
the  reorganization. 

Upon  receiving  the  bonds  the  depositary  issues  a 
certificate  of  deposit  to  the  depositor.  Temporary 
receipts  are  usually  issued,  which  are  later  exchanged 
for  the  engraved  certificates  of  deposit. 

Certificate  of  deposit;  its  transfer;  negotiability; 
rights  of  transferor  and  transferee;  interest 
on  bonds  represented  by  certificates  of  deposit. 

The  certificate  of  deposit  is  a  writing  issued  by 
the  depositary  upon  receiving  the  bonds  or  other 
securities  deposited  under  the  agreement.  It  is  in 
such  form  as  the  committee  shall  approve.  It  in- 
variably certifies  that  the  depositary  has  received 
from  the  depositing  party  certain  bonds,  describing 
them,  with  coupons  attached,  if  that  be  the  case; 
that  the  bonds  have  been  deposited  subject  to  the 
terms  and  conditions  of  the  agreement  for  reorgan- 
ization and  that  the  holder  of  such  certificate,  by 


354  RAILROAD  BONDS  AND  NOTES 

accepting  it,  consents  to  and  is  bound  by  the  provi- 
sions of  the  agreement  and  is  entitled  to  share  in 
all  benefits  and  advantages  of  the  reorganization; 
or  (it  continues),  the  bonds  so  deposited,  together 
with  the  coupons  attached,  may  be  returned  to  or 
withdrawn  by  the  holder  of  the  certificate,  upon 
compliance  with  the  terms  of  the  agreement,  by  pre- 
senting and  surrendering  the  certificate,  duly  en- 
dorsed. The  certificate  further  states  that  it  is  trans- 
ferable only  on  the  books  kept  for  that  purpose  at 
the  office  of  the  depositary,  upon  surrender  of  such 
certificate,  duly  endorsed,  and  thereupon  a  new  cer- 
tificate will  be  issued  to  the  transferee  in  exchange. 

The  committee  usually  has  the  power  to  declare 
the  transfer  or  registration  books  of  the  depositary 
closed,  from  time  to  time,  for  such  periods  as  it  may 
deem  expedient. 

The  certificate  of  deposit  may  be  made  payable  to 
bearer.  It  is  then  transferable  by  delivery  from 
hand  to  hand.  As  a  rule,  however,  these  certifi- 
cates are  not  made  payable  to  bearer,  but  are  made 
in  the  name  of  the  depositor,  and  each  transfer  must 
be  registered  on  the  books  of  the  depositary,  if  its 
new  owner  wishes  to  claim  rights  as  a  party  to  the 
reorganization.  When  in  this  usual  form,  to  trans- 
fer it,  it  is  presented  and  surrendered  to  the  depos- 
itary and  a  new  certificate  is  issued  in  its  place,  which 
is  in  turn  registered  in  the  name  of  the  new  owner. 

The  certificate  of  deposit  is  impressed  with  the 


REORGANIZATION  OF  THE  RAILROAD     355 

terms  of  the  agreement  into  the  hands  of  whom- 
soever it  may  be. 

Should  the  holder  of  a  certificate  transfer  it,  the 
new  holder  becomes  substituted  in  his  place  as  a 
party  to  the  agreement  and  is  entitled  to  all  its 
benefits  and  charged  with  all  its  duties. 

It  is  invariably  provided  in  the  agreements,  that 
the  holders  or  bearers  for  the  time  being  of  nego- 
tiable certificates  of  deposit,  and  the  registered  hold- 
ers for  the  time  being  of  registered  certificates  of 
deposit,  may  be  regarded  as  the  absolute  owners 
thereof  and  possessed  of  all  the  rights  and  charged 
with  all  the  duties  of  the  original  owners. 

Certificates  of  deposit  are  sometimes  listed  on  the 
stock  exchanges. 

They  do  not  draw  interest.  Of  course,  the  inter- 
est on  the  bond  continues  to  run  during  the  fore- 
closure action,  but  it  is  not  paid  as  a  rule,  unless 
there  is  money  on  hand  for  that  purpose  and  the 
court  orders  the  receiver  to  do  so.  Should  condi- 
tions warrant  it  the  court  may  order  the  receiver  to 
pay  the  instalment  of  interest  due.  As  the  commit- 
tee is  to  all  intents  and  purposes  the  owner  of  the 
deposited  bonds  so  far  as  the  right  to  receive  the 
interest  or  principal  thereof  is  involved,  the  interest 
is  paid  to  it.  The  depositary,  however,  usually  re- 
ceives this  money  and  at  the  direction  of  the  com- 
mittee, pays  it  over  to  the  holders  of  the  certificates 
of  deposit. 


356  RAILROAD  BONDS  AND  NOTES 

When  the  interest  is  not  paid  by  the  receiver  un- 
der order  of  the  court,  on  the  deposited  bonds,  the 
committee  may  advance  to  the  holders  of  the  certifi- 
cates the  amount  of  such  interest  as  a  loan  from  it 
to  them.  To  raise  the  money  necessary  for  such 
advances,  the  committee  may  pledge  such  bonds  and 
their  unmatured  coupons.  When  such  a  loan  is 
made  it  is  noted  on  the  certificate  of  deposit  held 
by  the  party  receiving  the  money.  Should  a  party 
withdraw  from  the  agreement,  he  shall  not  be  en- 
titled to  receive  the  bonds  represented  by  his  cer- 
tificate of  deposit  until,  among  other  things,  he  has 
returned  such  interest  so  advanced  to  him  with  in- 
terest thereon. 

When  the  reorganization  has  been  carried  out  the 
certificates  are  surrendered  to  the  depositary  and 
the  new  securities  are  delivered  in  their  place. 

Synopsis  of  the  plan  for  reorganization. 

The  plan  contains  the  details  of  the  arrangement 
by  which  the  property  of  the  insolvent  road  is  to 
be  acquired  at  the  foreclosure  sale  or  otherwise,  the 
terms  under  which  the  corporation  shall  be  recr^n- 
ized  or  a  new  corporation  formed,  how  the  property 
acquired  shall  be  transferred  and  held  by  such  new 
company,  what  stock  and  securities  the  new  corpo- 
ration shall  issue,  the  rights  and  standing  that  the 
bondholders,  the  other  creditors,  and  the  stockhold- 
ers, shall  have  in  the  reorganized  corporation  or  the 


REORGANIZATION  OF  THE  RAILROAD     357 

new  corporation,  and  what  stock  or  securities  shall 
be  allotted  to  each  to  represent  his  interest  in  the 
reorganized  or  the  new  corporation,  the  assessments 
that  shall  be  levied  against  stockholders  and  others, 
and  such  other  matters  are  provided  for  as  in  each 
particular  case  the  exigencies  require. 

The  plan  has  such  financing  in  view  as  will  start 
the  new  corporation  in  business  on  a  promising  basis. 
The  stockholders  of  the  old  corporation,  it  usually 
provides,  may  become  such  of  the  new  corporation 
upon  paying  a  specified  sum  for  each  share  of  stock 
issued  to  them.  The  plan  may  contemplate  also 
an  issue  of  bonds  by  the  new  corporation  to  raise 
money,  among  other  purposes,  to  pay  off  receivers' 
certificates  or  other  charges  or  liens  existing  or  con- 
tinuing against  the  property  with  which  it  shall  do 
business. 

Where  the  property  against  which  mortgages  are 
liens  is  taken  over  by  the  new  corporation  subject 
to  such  mortgages,  holders  of  the  bonds  of  the  old 
company  secured  by  such  mortgages  may  deem  it 
advisable  to  assist  the  new  corporation,  and,  accord- 
ingly, may  surrender  their  bonds  and  in  exchange 
take  bonds  of  the  new  corporation  at  a  lower  rate 
of  interest,  extending  the  time  of  payment,  and 
sometimes  for  a  less  amount,  releasing  the  balance. 
Sometimes  the  bondholders  may  think  it  good  policy 
to  waive  their  lien  against  such  property,  under  their 
mortgage,  in  favor  of  a  new  issue  that  the  new  cor- 


358  RAILROAD  BONDS  AND  NOTES 

poration  puts  out  or  exchange  their  bonds  for  those 
of  such  new  issue. 

In  these  and  other  ways  that  the  plan  may  con- 
tain, the  effort  is  made  to  start  the  new  corporation 
on  a  financial  basis  as  satisfactory  as  the  conditions 
warrant. 

The  plan  may  contain  provisions  for  assessments 
which  the  committee  shall  have  authority  to  levy  in 
its  discretion  against  the  parties  participating  in  the 
reorganization;  a  maximum  amount  may  be  fixed, 
however,  beyond  which  the  committee  shall  not  go 
in  assessing  each  bond  or  share  of  stock. 

Filing  the  plan;  giving  notice  thereof;  reasonable 
opportunity  to  examine  it;  proposed  changes; 
remedies  when  committee  fails  to  file  plan  or 
give  proper  notice. 

Sometimes  the  committee  is  given  the  authority, 
in  its  discretion,  to  adopt  a  plan  and  put  the  same 
into  operation  without  submitting  it  to  the  parties 
to  the  agreement  for  their  approval.  Any  plan 
adopted  under  such  authority,  in  the  absence  of  any 
fraud  or  abuse  of  power,  is  binding  on  all  the  parties 
to  the  agreement. 

Usually,  however,  it  is  the  duty  of  the  committee 
to  submit  the  plan,  or  any  material  changes  in  it, 
to  all  the  parties  to  the  agreement  for  their  approval 
or  disapproval. 

When  it  is  the  duty  of  the  committee  to  submit 


REORGANIZATION  OF  THE  RAILROAD      359 

the  plan  to  the  parties  to  the  agreement  for  their 
approval  or  rejection,  it  must  file  its  proposed  plan 
with  the  depositary.  Each  party  to  the  agreement 
is  entitled  to  notice  of  the  fact  that  the  plan  has 
been  filed,  so  that  he  may  examine  it  and  acquaint 
himself  with  its  terms.  This  matter  of  notice  is 
usually  provided  for  in  the  reorganization  agree- 
ment. The  usual  provision  is  that  the  notice  shall 
be  published  in  newspapers  of  general  circulation  in 
specified  cities  that  are  recognized  financial  centers, 
and  sometimes,  in  addition,  that  copies  of  the  notice 
and  the  plan  shall  be  mailed  to  each  registered  holder 
of  the  certificates  of  deposit,  to  his  address  as  the 
same  appears  on  the  books  of  the  depositary. 

Should  the  committee  propose  making  material  or 
important  changes  in  the  plan,  when  it  is  its  duty 
to  submit  the  same  to  the  parties  to  the  agreement, 
it  must  file  such  changes  with  the  depositary,  and 
give  notice  thereof.  The  notice  and  manner  of  giv- 
ing it  are  usually  the  same  as  in  the  case  of  the  filing 
of  the  original  plan  just  discussed. 

Each  party  to  the  agreement  is  entitled  to  a  rea- 
sonable opportunity  to  examine  the  proposed  plan  or 
the  proposed  changed  plan. 

Should  the  committee,  when  it  is  required  to  do 
so,  fail  to  file  the  original  plan,  or  the  changed  plan, 
the  court  will  compel  it.  And  if  the  original  plan 
or  the  changed  plan  be  filed  under  such  conditions, 
as  to  time  and  circumstances,  that  the  parties  do  not 


360  RAILROAD  BONDS  AND  NOTES 

have  a  reasonable  opportunity  to  examine  it,  the 
court  will  relieve  them  of  any  default  they  may  be 
guilty  of  due  to  this  delinquency  of  the  committee. 
And  the  court  will  see  that  the  parties  are  accorded 
a  fair  chance  to  become  acquainted  with  the  terms 
of  these  documents,  so  that  they  may  determine  the 
course  they  shall  pursue  with  respect  to  them. 

How  plan  is  formulated  and  submitted ;  when  con- 
tained in  agreement;  discretion  of  committee 
to  adopt  plan;  submitting  plan  for  assent  or 
dissent;  expressing  assent  or  dissent;  amount 
necessary  to  approve  or  reject ;  written  assents 
or  dissents;  majority  and  minority  rights  on 
approval  or  rejection  of  plan. 

As  a  general  rule,  the  committee  formulates  the 
plan  or  adopts  one  formulated  by  others,  and  sub- 
mits it  to  the  parties  to  the  agreement  for  their 
approval  or  disapproval. 

Sometimes,  though  rarely,  the  plan  is  contained  in 
the  agreement  itself.  When  the  plan  is  contained 
in  the  agreement,  it  was  assented  to  by  all  when  they 
became  parties  to  the  agreement.  It  need  not  be 
submitted  to  them  again  for  their  approval. 

The  agreement  sometimes  leaves  it  to  the  commit- 
tee to  put  into  operation  such  plan  as  it  may,  in 
its  discretion,  believe  best.  When  the  committee 
is  given  this  discretionary  power  its  plan  is  not  sub- 
mitted to  the  parties,  as  they  are  bound,  under  the 


REORGANIZATION  OF  THE  RAILROAD      361 

circumstances,  by  whatever  plan  the  committee,  in 
good  faith  and  without  any  abuse  of  its  power,  may 
propose. 

But,  no  matter  how  uncontrolled  a  discretion  may 
be  given  the  committee,  its  acts  are  always  subject 
to  the  supervision  of  the  court.  Be  its  powers  ever 
so  broad,  the  committee,  at  all  times,  must  act  in 
good  faith  toward  the  parties  it  represents,  and  must 
not  abuse  or  misuse  the  powers  conferred  on  it. 

However,  the  agreement  may  declare,  and  it 
usually  does,  that  the  committee  shall  submit  its 
proposed  plan  to  the  parties  for  their  consideration. 
It  then  provides  for  the  manner  in  which  the  parties 
shall  express  their  assents  to  or  dissents  from  such 
plan. 

The  manner  in  which  assents  or  dissents  shall  be 
expressed  is  stated  in  the  agreement.  Some  agree- 
ments say  that  the  parties  to  the  agreement  wishing 
to  object  to  the  proposed  plan  shall  file  their  dissents 
with  the  depositary.  When  dissents  representing  a 
certain  proportion  in  amount  of  the  deposited  securi- 
ties have  been  thus  filed,  the  plan  shall  be  consid- 
ered rejected  and,  thereupon,  another  submitted. 
Should  the  requisite  number  of  dissents  not  be  filed, 
the  plan  is  considered  approved  and  binding  on 
all. 

Some  agreements  provide  for  the  withdrawal  of 
those  parties  who  do  not  wish  to  be  bound  by  the  pro- 
posed plan.  These  provisions  are  to  the  effect  that 


362  RAILROAD  BONDS  AND  NOTES 

those  who  do  not  approve  of  the  proposed  plan  and 
desire  to  withdraw  shall  surrender  their  certificates 
of  deposit  to  the  depositary,  and,  upon  paying  the 
amounts  charged  against  such  securities,  shall  receive 
in  return  securities  represented  by  such  certificate  of 
deposit  and  thereupon  shall  be  deemed  to  have  dis- 
sented from  the  plan  and  withdrawn  from  the  agree- 
ment and  are  relieved  from  all  liability  in  any 
further  proceedings  under  it. 

On  the  other  hand,  the  agreement  may  provide  for 
the  filing  of  assents  with  the  depositary;  and  that 
those  who  do  not  file  their  assents  shall  be  deemed  to 
have  objected  to  the  plan.  When  the  requisite 
amount  of  assents  have  been  filed  the  plan  is  deemed 
approved ;  should  the  requisite  amount  of  assents  not 
be  filed,  the  plan  fails  to  be  approved  and  another 
is  submitted. 

What  shall  constitute  the  requisite  amount  or  pro- 
portion of  assents  or  dissents,  to  approve  or  reject  a 
plan,  as  the  case  may  be,  and  the  time  within  which 
they  shall  be  filed,  are  fixed  usually  in  the  agreement, 
though  it  is  sometimes  left  to  the  committee  to  de- 
termine. 

The  rejection  of  the  plan  because  the  requisite 
amount  or  proportion  of  assents  have  not  been  filed, 
or  because  the  specified  amount  or  proportion  of  dis- 
sents have  been  filed,  results  in  another  plan  being 
submitted.  This  course  is  more  favored,  in  some 
cases,  than  that  which  permits  the  dissenting  parties 


REORGANIZATION  OF  THE  RAILROAD      363 

to  withdraw  their  securities;  for  should  large  hold- 
ings be  withdrawn,  the  resources  of  the  committee 
may  be  reduced  so  as  to  materially  interfere  with,  if 
not  prevent,  the  purchase  of  the  property  and  the 
carrying  out  of  the  reorganization. 

The  committee  gives  notice  by  advertisements  in 
the  newspapers,  or  in  such  other  manner  as  it  may 
believe  advisable,  whether  the  plan  is  adopted  or 
rejected. 

If  it  be  necessary  that  written  assents  or  dissents 
be  filed  they  must  be  executed  by  those  appearing 
as  the  registered  owners  of  the  certificates  of  deposit 
at  the  time  the  registration  or  transfer  books  of  the 
depositary  were  closed  for  that  purpose.  Or  the 
paper  may  be  executed  in  the  name  of  such  registered 
owner  by  some  one  duly  authorized. 

It  is  sometimes  provided  in  the  agreement  that  if 
the  plan  or  the  changed  plan,  as  the  case  may  be,  be 
approved  by  a  certain  majority  in  amount  of  the  cer- 
tificates of  deposit,  it  shall  be  binding  on  all  the  par- 
ties to  the  agreement,  notwithstanding  that  the 
minority  objects.  In  the  absence  of  such  a  provision 
the  consent  of  the  majority,  no  matter  how  large, 
cannot  affect  the  rights  of  the  minority  and  force 
upon  the  latter  a  plan  which  they  do  not  approve. 
However,  to  avoid  forcing  the  minority  into  a  plan 
it  does  not  approve  and  to  allow  it  to  withdraw 
under  such  circumstances,  the  provision  is  frequently 
inserted  in  reorganization  agreements  by  which  those 


364  RAILROAD  BONDS  AND  NOTES 

who  object  to  the  plan  or  the  changed  plan,  as  the 
case  may  be,  may  withdraw  from  the  agreement  and 
no  longer  be  bound  by  it. 

When  the  plan  of  the  majority  is  carried  out  under 
such  a  provision  in  the  agreement  as  just  mentioned, 
against  the  objection  of  a  minority,  the  court  will  see 
that  there  is  no  pretense  of  any  fraud  or  oppression 
in  what  the  majority  propose  doing  and  that  the 
interests  of  the  minority  are  protected. 

When  plan  takes  effect;   abandoning  plan  after 
adoption. 

Sometimes  the  agreement  mentions  when  the  plan 
shall  become  operative  and  take  effect,  but,  as  a  gen- 
eral rule,  this  is  left  to  the  committee,  in  its  dis- 
cretion, to  decide. 

Wlien  the  plan  is  made  operative  the  committee 
gives  notice  of  this  fact  by  advertisement,  or  in  such 
other  manner  as  it  may  believe  best. 

The  committee  decides  also  when  it  shall  proceed 
to  carry  out  the  terms  of  the  plan  after  it  has  become 
operative  by  approval  of  the  parties  or  by  the  will  of 
the  committee.  See  Discretion  of  committee  to 
adopt  plan;  submitting  plan  for  assent  or  dissent. 
Page  360. 

Under  the  usual  form  of  reorganization  agree- 
ment, the  powers  of  the  committee  with  relation  to 
carrying  out  the  plan  are  very  broad  and  quite  gen- 
erally include  the  authority  to  abandon  it,  notwith- 


REORGANIZATION  OF  THE  RAILROAD      365 

standing  that  it  has  been  declared  in  operation. 
Should  the  committee  abandon  the  plan,  the  parties 
to  the  agreement  who  have  deposited  are  entitled  to 
a  return  of  the  securities  represented  by  their  certifi- 
cates of  deposit,  and  thereafter  they  occupy  the  same 
position  as  they  did  before  they  became  parties  to 
the  agreement.  As  a  condition  of  the  return  of  the 
securities,  the  certificate  of  deposit  representing 
them  must  be  surrendered  and  the  proportionate 
share  of  the  expenses  of  the  reorganization,  charge- 
able against  them,  must  be  paid. 

Changes  in  the  agreement  or  the  plan;  power  of 
committee  to  make  changes;  uncontrolled 
power;  limited  to  certain  matters;  material 
changes;  submitting  changes  to  parties;  un- 
authorized changes;  ratification  or  rejection; 
ratification  by  majority;  changes  by  majority 
against  objection  of  minority;  provisions  for 
majority  control. 

Each  party  to  the  agreement  is  entitled  to  say 
whether  or  not  he  shall  be  bound  by  any  changes  in 
it  or  in  the  plan,  unless  he  has  conferred  on  the  com- 
mittee or  on  the  majority  of  the  holders  of  the  de- 
posited securities  the  power  to  speak  for  him  in  this 
regard  and  bind  him  by  their  acts. 

The  committee  is  usually  authorized  by  the  agree- 
ment to  supply  such  minor  omissions  and  remedy 
such  immaterial  defects  in  the  agreement  or  in  the 


366  RAILROAD  BONDS  AND  NOTES 

plan  as  in  its  absolute  and  uncontrolled  discretion  it 
may  think  proper  and  advisable. 

The  power  to  make  changes  in  the  agreement  or  in 
the  plan  is  delegated  usually  to  the  committee  by  the 
agreement.  It  is  then  a  matter  for  inquiry  as  to  the 
extent  of  the  authority  the  agreement  confers.  The 
agreement  may  give  the  committee  an  uncontrolled 
and  absolute  discretion  to  make  changes ;  or  its  action 
may  be  limited  to  changes  with  relation  to  certain 
specified  matters;  or  it  may  be  limited  to  changes 
with  regard  to  all  matters  which  are  immaterial  or 
are  not  substantial;  or  its  powers  may  be  regulated 
otherwise. 

Usually  agreements  provide  that  substantial  or 
material  changes  shall  be  submitted  by  the  commit- 
tee to  the  parties  for  their  approval  or  rejection. 
This  must  then  be  done. 

Some  agreements  empower  the  committee  to  de- 
cide whether  or  not  the  change  is  material  or  sub- 
stantial, and  declare  that  its  judgment  or  decision  in 
this  regard  shall  be  final  and  conclusive  and  all  the 
parties  to  the  agreement  shall  be  bound  thereby. 
Such  an  authority  is  so  broad  and  inclusive  that  the 
committee  under  it,  in  the  absence  of  bad  faith,  may 
act  almost  without  restriction. 

When  the  committee  is  required  to  submit  pro- 
posed changes  in  the  plan  or  in  the  agreement  to  the 
parties,  it  files  the  proposed  changes  with  the  de- 
positary, and  the  same  course  is  then  pursued  to 


REORGANIZATION  OF  THE  RAILROAD      367 

either  reject  or  accept  the  changes  as  in  the  case  of 
the  original  plan.  See  Submitting  plan  for  assent  or 
dissent.  Page  360. 

Sometimes  those  not  approving  the  changes  in  the 
plan  or  in  the  agreement  are  permitted  by  the  agree- 
ment to  withdraw;  then  those  continuing  carry  out 
the  reorganization.  But  as  a  large  majority  in 
amount  of  the  holdings  may  be  withdrawn  and  thus 
weaken  and  perhaps  render  ineffective  the  resources 
at  the  command  of  the  committee,  the  more  prudent 
method  is  often  favored  by  which,  should  the  pro- 
posed plan  not  be  approved  by  the  necessary  amount, 
or  should  it  be  rejected  by  the  filed  dissents,  that  it 
shall  be  considered  abandoned  and  another  sub- 
mitted. Though  under  the  arrangement  whereby 
the  parties  to  the  agreement  may  withdraw  their 
holdings  should  they  object  to  the  plan  or  the 
changes  in  the  plan  or  in  the  agreement,  it  is  some- 
times provided  that  the  committee  may  withdraw 
any  proposed  plan  or  changes  in  the  plan  or  in  the 
agreement  when  it  sees  that  too  many  of  the  parties 
are  withdrawing;  upon  the  committee  thus  retract- 
ing such  proposed  changes,  the  right  of  all  remain- 
ing parties  to  withdraw  immediately  ceases. 

A  majority  has  no  power  to  bind  a  minority  by  a 
consent  to  the  plan  or  to  changes  in  the  plan  or  in  the 
agreement ;  nor  has  it  the  power  to  bind  the  minority 
by  its  ratification,  acceptance,  or  confirmance  of  any 
unauthorized  plan  or  unauthorized  changes  in  the 


368  RAILROAD  BONDS  AND  NOTES 

plan  or  in  the  agreement,  unless  the  mortgage  or  the 
reorganization  agreement  specifically  gives  the  ma- 
jority this  right  to  bind  the  minority  in  these  partic- 
ulars. 

The  mortgage  or  the  agreement  may  provide  that 
a  majority,  or  a  majority  of  a  specified  amount,  may 
consent  to  the  plan  submitted,  or  to  the  changes  in 
the  plan  or  in  the  agreement,  and  that  their  consent 
in  these  particulars  shall  be  binding  on  all.  The 
only  obligation  on  the  majority  then  is  that  it  must 
act  in  good  faith  and  without  any  fraud  or  oppres- 
sion. 

When  a  change  is  made  in  the  agreement  or  in  the 
plan  by  reason  of  the  consent  of  the  majority  against 
the  objections  of  the  minority,  such  changes  will  be 
strictly  construed  and  the  court  will  regard  the  lan- 
guage employed  as  having  only  that  meaning  that  is 
plainly  expressed  by  its  terms  and  will  not  extend 
it  to  cover  by  inference  anything  else.  Should  there 
be  doubt  as  to  whether  or  not  the  language  of  the 
agreement  confers  this  power  on  the  majority,  the 
court,  under  these  circumstances,  when  there  is  a 
reasonable  opportunity  to  do  so,  will  decide  that  it 
does  not. 

Powers  of  the  committee;  defined  by  agreement; 
discretionary  powers;  positive  instructions. 

The  committee  as  a  rule  has  such  powers  only  as 
the  agreement  or  the  plan  gives  it.  Reorganization 


REORGANIZATION  OF  THE  RAILROAD     369 

agreements  quite  generally  give  the  committee  rather 
broad  and  all-inclusive  powers.  They  usually  au- 
thorize it  to  execute  all  writings  and  do  all  acts  that 
may  be  found  necessary  in  the  course  of  the  reorgan- 
ization proceedings  to  carry  out  the  terms  of  the 
agreement  or  the  plan.  In  fact  some  reorganization 
agreements  go  to  the  extent  of  conferring  on  the  com- 
mittee any  power  or  authority  that  it,  in  its  uncon- 
trolled discretion,  may  think  necessary  to  carry  out 
the  agreement,  even  though  such  power  or  authority 
be  not  expressed  or  contemplated  in  the  agreement. 
When  the  committee  is  not  given  the  power  to  act 
according  to  its  best  judgment  and  discretion,  it 
often  finds  in  the  course  of  its  work  that  it  is  ham- 
pered in  meeting  the  many  details  presenting  them- 
selves from  time  to  time  and  requiring  its  attention. 
It  would  be  impracticable  to  seek  the  advice  of  the 
parties  to  the  agreement  and  to  ask  their  permission 
to  act  in  such  minor  matters.  The  men  who  are  se- 
lected to  act  as  a  reorganization  committee  usually 
are  men  of  standing  and  skilled  in  that  kind  of  work; 
the  law,  independent  of  any  provision  in  the  agree- 
ment to  that  effect,  confers  on  the  committee  a 
reasonable  discretion  to  act  according  to  its  best 
judgment  in  minor  matters  and  details.  However, 
agreements  for  reorganization  usually  provide  for 
the  power  of  the  committee  in  minor  matters  and 
details,  and,  quite  generally,  go  further  than  the  law 
in  this  regard,  and  vest  in  the  committee  an  absolute 


370  RAILROAD  BONDS  AND  NOTES 

and  uncontrolled  discretion  in  carrying  out  all  the 
terms  of  the  agreement. 

However,  no  matter  how  broad  and  unlimited  a 
discretion  may  be  given  the  committee,  it  has  no 
power  to  disregard  any  positive  instructions  that  the 
agreements  may  contain. 

Committee  may  employ  representatives. 

The  committee  has  the  authority  to  employ  legal 
counsel,  agents,  or  other  representatives,  necessary 
to  carry  out  the  reorganization.  But  it  may  not 
delegate  to  others  the  exercise  of  that  executive  con- 
trol and  management  to  which  the  parties  to  the 
agreement  are  entitled  to  believe  the  committee  will 
give  their  personal  attention,  unless  the  agreement 
permits  it.  Sometimes  the  agreement  authorizes  the 
committee  to  appoint  managers,  sub-committees,  or 
other  representatives,  and  to  confer  on  them  the  same 
powers  that  it,  the  original  committee,  had  should  it 
deem  it  necessary  or  expedient;  and  it  is  usually 
further  provided  that  the  compensation  and  dis- 
bursements of  such  managers  or  sub-committees  shall 
be  charged  against  the  property  and  the  deposited 
securities,  as  an  expense  of  the  reorganization. 

Committee  may  construe,  remedy,  change,  prepare, 
adopt,  declare  operative,  abandon  plan. 

Agreements  for  reorganization  often  authorize  the 
committee  to  place  its  own  construction  upon  the 


REORGANIZATION  OF  THE  RAILROAD     371 

terms  of  the  agreement  and  to  say  just  what  the  lan- 
guage employed  shall  mean;  and,  further,  that  the 
construction  the  committee  so  places  upon  the  terms 
of  the  agreement  shall  be  final  and  binding  on  all  the 
parties. 

Reorganization  agreements  also  quite  generally 
confer  the  power  on  the  committee  to  supply  any 
omissions  or  remedy  any  defects  in  the  agreement  or 
the  plan  that  in  its  judgment  it  believes  necessary  to 
carry  out  the  purposes  of  such  agreement  or  plan. 
In  thus  construing  the  terms  of  the  agreement,  and  in 
supplying  omissions,  and  in  curing  defects,  the  com- 
mittee must  act  in  good  faith. 

The  committee  may  be  empowered  by  the  agree- 
ment to  make  changes  in  the  plan  or  in  the  agree- 
ment; or  the  agreement  may  declare  such  changes 
may  be  made  only  on  the  approval  of  the  parties 
themselves. 

The  agreement  usually  grants  to  the  committee 
the  authority  to  prepare  a  plan  for  reorganization  or 
to  approve  and  to  adopt  a  plan  though  not  prepared 
by  it.  That  it  shall  then  submit  such  plan,  whether 
prepared  or  approved  or  adopted  by  it,  to  the  parties 
for  their  approval  or  disapproval;  and,  sometimes, 
the  agreement  lets  it  to  the  committee  to  decide  when 
sufficient  assents  to  the  plan  have  been  filed  to  ap- 
prove it,  and  when  the  necessary  dissents  have  been 
filed  to  disapprove  it.  The  agreement  may  also  give 
the  committee  the  authority  to  limit  the  period  or 


372  RAILROAD  BONDS  AND  NOTES 

extend  the  time  within  which  the  parties  to  the  agree- 
ment shall  assent  to  or  dissent  from  the  plan  sub- 
mitted by  it.  Some  agreements  provide  that  all  the 
parties  to  it  shall  be  bound  by  any  plan  that  the  com- 
mittee shall  submit;  in  such  case  the  only  limitation 
on  the  committee  is  that  it  shall  act  in  good  faith. 

It  is  left  to  the  committee  usually  to  declare  when 
the  plan  shall  become  operative  and  go  into  effect, 
and  when  it  shall  proceed  to  carry  out  its  terms. 

The  committee  is  sometimes  given  the  power  to 
declare  the  plan  abandoned  even  after  it  has  declared 
it  operative. 

Allowing  parties  to  join  in  the  reorganization;  co- 
operation with  other  committees. 

Agreements  sometimes  give  the  authority  to  the 
committee  to  permit  the  stockholders  and  different 
aggregations  of  creditors  of  the  insolvent  road  to 
join  in  the  reorganization  proceedings,  should  it 
deem  it  advisable,  and  to  fix  the  terms  upon  which 
they  shall  become  parties. 

As  a  general  rule,  reorganization  agreements  give 
the  committee  the  power  to  limit  the  period  within 
which  the  bonds  or  other  securities  may  be  deposited, 
together  with  the  further  power  to  extend  such  time 
and  to  impose  a  penalty  as  a  condition  of  receiving 
them  after  the  original  period  has  expired. 

When  the  reorganization  may  be  conducted  ad- 
visedly in  conjunction  with  another,  proposed  by 


REORGANIZATION  OF  THE  RAILROAD      373 

other  persons  interested  in  other  parts  of  the  insol- 
vent road,  or  with  the  holders  of  other  securities  or 
obligations  of  the  company  interested  in  the  same 
part,  the  committee  is  usually  empowered  by  the 
agreement  to  participate  in  and  cooperate  with  such 
other  proceedings. 

Power  of  the  committee  over  deposited  bonds. 

With  relation  to  the  deposited  securities,  agree- 
ments for  reorganization  customarily  confer  on  the 
committee  the  authority  to  collect  and  receive  all 
sums  due  on  them,  and  to  act  with  relation  to  them 
as  if  it  were  the  owner,  subject,  however,  to  the  terms 
of  the  agreement.  The  committee  may  attend  meet- 
ings of  the  holders  of  the  bonds  under  that  issue  and 
may  vote  on  such  deposited  bonds,  stocks  and  other 
securities. 

The  agreement  invariably  authorizes  the  commit- 
tee to  use  the  deposited  bonds  in  whole  or  in  part  pay- 
ment of  the  purchase  price  of  the  property  of  the 
road  to  be  bought  for  the  purposes  of  the  reorganiza- 
tion, or  to  pledge  them  to  procure  the  funds  to  pay 
such  purchase  price. 

It  is  also  usual  that  the  committee  shall  have  the 
power  to  pay  off  or  to  satisfy  claims  entitled  to  prior 
payment  and  secured  by  prior  liens  against  the  prop- 
erty of  the  insolvent  road  that  it  has  purchased  at 
the  foreclosure  sale  or  otherwise  acquired,  if  in  its 
opinion  it  will  protect  the  deposited  bonds  and  be 


374  RAILROAD  BONDS  AND  NOTES 

to  the  best  interests  of  the  parties  to  the  reorganiza- 
tion. 

Pursuing  the  remedies  of  the  bondholders. 

All  litigation  necessary  to  protect  the  rights  and 
remedies  of  the  holders  of  the  deposited  securities, 
which  such  holders  might  have  conducted  but  for  the 
reorganization,  may  be  carried  on  by  the  committee. 
The  committee,  generally  speaking,  stands  as  the 
owner  of  the  deposited  securities.  The  committee, 
under  the  usual  form  of  agreement,  has  the  authority 
to  request  the  trustee  to  pursue  all  remedies  and  to 
institute  or  to  defend  any  legal  proceedings  or  ac- 
tions necessary  to  enforce  payment  of  the  deposited 
bonds;  should  it  believe  it  advisable  for  the  protec- 
tion of  the  parties  to  the  agreement. 

Committee  may  acquire  property;  its  powers  with 
respect  to  same. 

Under  the  usual  form  of  agreement  the  committee 
may  take  such  steps  as  it  believes  necessary  to  pur- 
chase or  to  acquire  the  property  of  the  insolvent  road 
for  the  purpose  of  carrying  out  the  objects  of  the  re- 
organization or  the  plan,  and  may  deal  with  the 
property  so  acquired  as  if  it  were  the  actual  owner; 
but  the  agreement  usually  provides  that  the  com- 
mittee shall  not  be  bound  to  make  such  purchase 
merely  because  it  is  authorized  to  do  so. 

The  agreement  also  usually  empowers  the  commit- 


REORGANIZATION  OF  THE  RAILROAD      375 

tee  to  sell  any  or  all  property  acquired,  in  such  man- 
ner and  at  such  prices  as  in  its  discretion  it  thinks 
best,  if  it  believe  it  advisable  in  the  course  of  the 
reorganization. 

The  committee  is  also  quite  generally  authorized 
to  pay  off  any  bonds  or  notes,  or  other  obligations  of 
the  insolvent  company,  that  are  secured  by  property 
or  by  collateral,  the  acquisition  of  which  property  or 
collateral  the  committee  may  deem  advantageous  or 
advisable  for  the  purposes  of  the  reorganization. 
And  it  may  use  the  deposited  securities  to  make  such 
payments  or  may  pledge  them  to  raise  the  money  nec- 
essary therefor. 

Expenditures  and  debts  by  committee;  expenses; 
may  consent  to-  receiver's  certificates. 

Reorganization  agreements  also  quite  generally 
confer  on  the  committee  the  power  to  make  necessary 
expenditures,  to  borrow  money,  and  to  incur  such 
debts  as  in  its  discretion  it  thinks  necessary  to  carry 
out  the  reorganization  or  to  protect  the  interests  of 
the  parties  to  the  agreement,  and  to  pledge  the  de- 
posited bonds  and  all  property  it  may  have  acquired 
to  secure  the  payment  of  the  debts  so  incurred,  in- 
cluding its  own  expenses  and  compensation.  This 
includes  also  the  compensation  and  disbursements  of 
the  managers,  subcommittees  and  other  representa- 
tives, that  it  may  have  properly  employed. 

Though  the  authority  to  do  so  may  not  be  granted 


376  RAILROAD  BONDS  AND  NOTES 

specifically,  yet  under  some  of  the  powers  granted  to 
the  committee  the  power  may  be  inferred  and,  ac- 
cordingly, it  may  join  in  and  assent  to  an  applica- 
tion by  the  receiver  for  the  issuance  of  receiver's  cer- 
tificates, which  under  the  order  of  the  court  may  be 
given  a  priority  in  payment  over  the  bonds  and  other 
securities  deposited  under  the  reorganization  agree- 
ment. 

Personnel  of  the  committee. 

The  agreement  usually  empowers  the  committee 
to  fill  any  vacancies  in  its  membership;  and  some- 
times to  add  to  its  numbers  such  additional  members 
as  it  may  deem  necessary.  Sometimes  the  commit- 
tee reserves  to  itself  the  right  to  withdraw  at  any 
time  upon  giving  due  notice  to  the  depositing  security 
holders.  Under  these  circumstances  the  depositing 
security  holders  are  entitled  to  the  return  of  securi- 
ties represented  by  their  certificates  of  deposit,  upon 
paying  their  proportionate  shares  of  the  expenses  in- 
curred and  any  sum  that  may  have  been  advanced  to 
them  with  interest  thereon. 

Individual  interest  of  the  committee. 

Reorganization  agreements  quite  generally  provide 
that  any  member  of  the  committee  and  any  firm  or 
corporation  of  which  the  committee  or  any  of  its 
number  may  be  a  member  or  officer,  may  become 
pecuniarily  interested  in  the  property  or  in  the  securi- 


REORGANIZATION  OF  THE  RAILROAD      377 

ties  that  may  be  involved  in  the  agreement  or  the 
plan  or  be  acquired  under  them. 

Duties  of  the  committee ;  good  faith ;  will  of  major- 
ity ;  accounting ;  time  within  which  to  complete 
reorganization;  five  years'  provision. 

Generally  speaking,  the  committee  is  charged  with 
the  duty  of  carrying  out  the  terms  of  the  agreement 
and  the  plan.  It  should  be  remembered,  however, 
that  under  the  usual  form  of  agreement,  the  commit- 
tee may  withdraw  at  any  time  and  may  abandon  the 
agreement  and  the  plan,  though  it  has  declared  the 
latter  operative  and  in  effect.  But  in  carrying  out 
any  work  that  it  has  undertaken  it  is  accountable  for 
its  actions. 

The  committee  must  act  at  all  times  in  good  faith. 

The  duties  which  the  committee  assumes  it  owes  to 
each  party  to  the  agreement.  It  acts  for  all  the  par- 
ties and  not  for  a  majority,  no  matter  how  large, 
unless  the  agreement  provides  that  the  will  of  the 
majority  shall  prevail  with  relation  to  the  matter  in 
question. 

The  committee,  therefore,  has  no  power  to  disre- 
gard any  positive  instructions  contained  in  the  agree- 
ment at  the  request  of  the  majority.  Each  party 
may  insist  that  the  committee  fully  perform  its  du- 
ties according  to  the  terms  of  the  agreement;  and 
should  he  suffer  a  pecuniary  loss  by  reason  of  any 
wrongdoing  by  the  committee,  he  is  entitled  to  sue 


378  RAILROAD  BONDS  AND  NOTES 

and  recover  damages  from  the  committee  personally, 
unless  the  act  be  one  for  which  the  agreement  or  the 
law  declares  the  committee  shall  not  be  liable. 

When  the  committee  has  carried  out  the  reorgan- 
ization, or  if  the  proceedings  have  been  terminated 
sooner,  it  must  file  with  the  depositary  an  accounting 
of  its  receipts  and  disbursements.  The  agreement 
usually  provides  that  upon  filing  this  accounting,  the 
committee  shall  be  discharged  from  further  liability 
with  respect  to  the  agreement  or  the  plan.  See  Ac- 
counting and  discharge.  Page  382. 

The  manner  of  and  the  time  for  the  performance 
of  many  of  the  duties  of  the  committee  are  left 
largely,  as  was  seen,  to  its  discretion.  The  time 
within  which  it  shall  submit  a  plan  is  left  also  to  its 
discretion. 

The  period  within  which  it  shall  carry  out  the 
terms  of  the  agreement  and  the  plan,  and  otherwise 
perfect  the  reorganization,  and  deliver  to  the  parties 
the  securities  of  the  new  corporation  or  return  the  de- 
posited securities,  is  left  usually  to  its  discretion; 
though  most  agreements  fix  such  period  at  five  years 
in  order  to  comply  with  the  rules  of  the  Committee 
on  Stock  List  of  the  New  York  Stock  Exchange.  It 
is  usually  contemplated  by  the  parties  that  the  reor- 
ganization shall  be  completed  within  a  shorter  pe- 
riod. 

While  the  committee  may  not  be  limited  as  to  the 
time  within  which  it  shall  complete  the  reorganiza- 


REORGANIZATION  OF  THE  RAILROAD     379 

tion,  should  it  neglect  its  duties  and  not  proceed  for 
an  unreasonable  time,  the  court  may  declare  the 
agreement  abandoned  and  relieve  the  parties  from 
any  further  obligations  under  it. 

Personal  liability  of  the  committee;  money  dam- 
ages; injunction;  compelling  performance  of 
duties ;  declaring  acts  void ;  error  of  judgment ; 
limitation  of  liability;  who  affected  by  limita- 
tion ;  liability  to  third  persons ;  liability  for  acts 
of  co-members ;  accounting  and  discharge. 

The  committee  is  liable,  ordinarily,  to  any  party 
to  the  agreement  who  suffers  a  pecuniary  loss  by 
reason  of  its  wrongdoing  in  carrying  out  the  reorgan- 
ization, or  with  relation  to  any  of  the  matters  con- 
tained in  the  agreement.  The  liability  of  the  com- 
mittee in  favor  of  the  parties  to  the  agreement  is  not 
charged  against  the  property  in  its  custody,  as  this 
liability  is  a  personal  one. 

The  law  awards  any  party  to  the  agreement  who 
has  suffered  a  financial  loss,  by  reason  of  the  wrong- 
ful acts  of  the  committee,  damages  in  money  to  com- 
pensate him  for  such  loss ;  and  the  court  may  stop,  by 
injunction,  any  wrongful  act  the  committee  threat- 
ens to  do.  Should  the  committee  have  carried  out 
the  wrongful  act,  the  court  may,  under  proper  cir- 
cumstances, set  it  aside  and  declare  it  void  and  of  no 
effect. 

As  was  seen,  the  committee  is  often  vested,  in 


380  RAILROAD  BONDS  AND  NOTES 

many  matters,  with  discretion  and  justified  in  such 
cases  in  acting  according  to  its  best  judgment.  An 
error  of  judgment  where  there  is  no  bad  faith  will 
not  subject  the  committee  to  any  liability  even 
though  it  may  have  caused  damage. 

Reorganization  agreements,  however,  usually 
grant  the  committee  a  certain  protection  and  im- 
munity from  liability  by  declaring  that  neither  the 
committee  nor  any  of  its  members  shall  be  liable  to 
any  of  the  parties  to  the  agreement  for  any  act  or 
omission  to  act  of  any  of  its  representatives,  provided 
it  has  selected  these  representatives  in  good  faith. 
Its  only  duty  with  respect  to  its  representatives  is 
that  it  shall  use  reasonable  care  in  selecting  them ;  if 
the  committee  has  done  that,  according  to  these  pro- 
visions, it  is  not  liable  for  any  wrong  act  of  its  repre- 
sentatives. The  agreements  also,  as  an  invariable 
rule,  provide  that  the  committee  shall  not  be  liable 
for  anything  other  than  its  own  wilful  wrongdoing 
or  gross  negligence.  It  seems,  too,  from  the  trend 
of  decisions  that  the  courts  hold  the  members  of  a 
reorganization  committee  personally  liable  only  for 
its  own  gross  negligence  or  wilful  wrong,  even  where 
the  agreements  do  not  make  such  a  provision. 

The  committee,  as  a  rule,  by  these  provisions  in 
the  agreement,  seeks  to  avoid  personal  liability  as  it 
feels  that  it  is  acting  for  the  protection  and  benefit 
of  all  the  parties  to  the  agreement;  hence  these  pro- 


REORGANIZATION  OF  THE  RAILROAD      381 

visions  that  exempt  it  from  personal  liability  in  all 
cases  except  where  it  has  itself  done  wrong  wilfully 
or  is  grossly  careless. 

Notwithstanding  any  provisions  in  the  agreement 
by  which  the  parties  to  it  (the  committee,  the  de- 
positary, and  the  depositors  of  the  securities)  may 
agree  to  limit  the  liability  of  the  committee  as  to 
themselves,  it  remains  liable  under  the  ordinary  rules 
of  law  to  all  third  persons  to  whom  it  may  cause 
any  damage;  for  such  third  persons  are  not  bound 
by  agreements  to  which  they  are  not  parties.  These 
limitations  of  the  liability  of  the  committee  can 
affect  only  those  who  are  parties  to  it  and  relieves 
the  committee  only  in  its  relations  with  such  parties. 

Should  the  committee  in  the  course  of  carrying  out 
the  reorganization  or  the  plan  become  liable  to  third 
persons  on  an  official  contract,  or  by  reason  of  some 
official  act  or  negligence  in  carrying  out  an  official 
act,  its  liability  is  in  its  representative  capacity  as  a 
committee.  The  damages  in  such  a  case  are  regarded 
as  an  expense  of  the  reorganization  and  are  paid  out 
of  the  property  the  committee  has  acquired  under  the 
reorganization  agreement,  including  the  deposited  se- 
curities. 

Ordinarily,  in  cases  of  co-trusteeship — which  re- 
lation the  members  of  the  reorganization  committee 
bear  to  each  other — one  trustee  is  not  liable  for  the 
acts  of  the  other,  except  in  those  cases  where  with 


382  RAILROAD  BONDS  AND  NOTES 

knowledge  of  the  facts  he  stands  by  without  protest 
and  permits  his  associate  to  do  wrong.  This  seem- 
ing acquiescence  in  the  wrong  act  and  failure  to  ob- 
ject renders  him  as  legally  liable  as  if  he  had  actually 
participated.  And  even  though  he  be  ignorant  of 
the  acts  of  his  wrong-doing  associate,  if  the  circum- 
stances be  such  that  he  should  have  known  what  was 
going  on,  he  is  negligent  in  not  knowing,  and  he  is 
charged  with  the  same  knowledge  and  liability  as  if 
he  were  actually  cognizant  of  the  act  complained  of 
and  permitted  it  to  be  done  without  protest.  How- 
ever, most  agreements  provide  that  one  member  of 
the  committee  shall  not  be  liable  for  the  acts  of  any 
other  member. 

It  is  the  duty  of  the  committee  to  render  an  ac- 
counting of  its  acts  while  in  office.  Reorganization 
agreements  usually  provide  that  when  the  committee 
has  filed  such  an  accounting  with  the  depositary,  or 
has  returned  to  the  parties  to  the  agreement  the  se- 
curities they  have  deposited  under  it  and  represented 
by  their  certificates  of  deposit,  or  has  delivered  to 
them  the  securities  of  the  new  corporation  to  which 
they  are  entitled,  then  all  duties  and  liabilities  of  the 
committee  to  the  parties  to  the  agreement  shall  cease. 
But  any  of  the  parties  are  entitled  to  have  the  acts  of 
the  committee  and  its  accounting  reviewed  by  the 
court  should  there  exist  legal  ground  therefor,  such 
as  fraud,  or  other  evidence  of  bad  faith. 


REORGANIZATION  OF  THE  RAILROAD     383 

Purchase  of  property  of  insolvent  road  by  bond- 
holders or  committee ;  using  bonds  in  payment ; 
payment  of  costs  in  cash;  when  purchased  by 
others;  committee  using  own  money;  failure 
to  complete  purchase;  deficiency  on  resale. 

Experience  has  shown  that  a  fair  price  can  be  ob- 
tained and  a  sacrifice  avoided  in  the  sale  of  the  prop- 
erty of  the  insolvent  road  at  foreclosure  only  by  the 
bondholders  under  the  foreclosed  mortgage  using 
their  bonds  in  bulk  to  make  the  purchase.  Accord- 
ingly, the  bondholders  under  the  foreclosed  mort- 
gage, or  the  reorganization  committee  representing 
them,  are  permitted  to  pay  their  bid  in  whole  or  in 
part  with  their  bonds  and  the  balance,  if  any,  in  cash. 

The  bondholders  under  the  foreclosed  mortgage 
are  thus  permitted  to  use  their  bonds  in  the  purchase 
because  the  proceeds  of  the  foreclosure  eventually 
will  come  to  them  in  money. 

Each  bond  is  accepted  for  such  sum  as  it  is  entitled 
to  receive  as  its  proportionate  share  of  the  proceeds 
of  the  sale.  Each  bond  is  accepted  for  such  an 
amount  as  it  would  receive  upon  a  final  distribution. 

However,  this  payment  of  the  bid  by  the  bond- 
holders, or  their  committee,  with  bonds  secured  by 
the  foreclosed  mortgage,  is  usually  subject  to  the  con- 
dition that  the  costs  and  charges  of  the  litigation  and 
of  the  trusteeship  and  the  expenses  of  the  sale  shall 
be  paid  in  cash. 


384  RAILROAD  BONDS  AND  NOTES 

The  court  in  ordering  the  foreclosure  sale  may,  in 
its  decree,  declare  that  should  the  purchaser  not  be 
a  bondholder  under  the  foreclosed  mortgage,  he  shall 
pay  at  once,  in  cash,  part  of  his  bid  as  a  deposit  or 
earnest  money. 

Should  some  of  the  parties  to  the  agreement  not 
pay  their  proportionate  shares  of  the  assessments  or 
charges  levied  by  the  committee  in  order  to  make  the 
purchase,  and  the  committee,  with  money  that  it  has 
furnished  itself,  completes  the  purchase,  the  court 
will  hold  that  it  has  not  acquired  the  property  as  in- 
dividuals but  that  such  committee  holds  it  in  trust 
for  and  as  the  representatives  of  those  who  have  com- 
plied with  the  terms  of  the  agreement  and  have  con- 
tributed their  pro  rata  shares.  For  such  sums  as  the 
committee  has  advanced,  it  is  entitled  to  be  reim- 
bursed from  those  who  have  accepted  its  purchase, 
and  the  property  purchased  is  charged  with  the  pay- 
ment of  such  moneys  so  advanced  before  the  bond- 
holders receive  anything  therefrom. 

Should  the  bondholders  or  the  committee,  as  the 
case  may  be,  conclude  that  the  price  bid  at  the  fore- 
closure sale  was  too  high  and  that  it  would  not  be 
advisable  to  take  over  the  property  and  operate  it  at 
that  figure,  the  property  is  sold  again,  under  the 
order  of  the  court,  and  if  on  the  resale  it  should  bring 
less,  then  the  parties  to  the  agreement  may  be  held 
liable  for  the  deficiency.  They  are  not  entitled 
ordinarily  to  the  return  of  the  deposit  made. 


385 

Parties  to  the  agreement  are  bound  by  all  proper 
acts  of  the  committee;  rule  when  committee 
acts  wrongfully;  ratification  of  unauthorized 
acts;  remedies  for  wrongful  acts. 

The  parties  to  the  agreement  are  bound  by  all  acts 
of  the  committee  when  acting  within  the  scope  of  its 
authority  in  carrying  out  the  terms  of  the  agreement 
or  the  plan.  They  are  not  bound,  however,  when 
the  committee  acts  fraudulently  nor  when  it  acts  in 
violation  or  in  excess  of  its  authority. 

Should  the  parties  to  the  agreement  ratify,  con- 
firm, adopt,  or  accept,  by  word  or  conduct,  any  unau- 
thorized action  of  the  committee,  they  are  bound  by 
it  with  the  same  effect  as  if  the  act  had  been  author- 
ized before  it  was  done.  To  reject  an  unauthorized 
act  of  the  committee,  the  party  must  proceed  to  do 
so  without  delay  after  becoming  acquainted  with  the 
facts.  A  failure  to  act  promptly  under  those  circum- 
stances may  be  construed  as  an  acquiescence  in  the 
act  complained  of,  and  an  acceptance  of  it.  Silence 
for  an  unreasonable  period  after  learning  of  the  un- 
authorized action  may  be  construed  as  a  consent  to  it. 

Should  the  committee  threaten  to  carry  into  effect 
an  act  that  is  tainted  with  fraud  or  which  is  in  viola- 
tion or  in  excess  of  its  authority,  the  court  may  stop 
it  by  injunction ;  or  if  the  act  has  already  been  carried 
out,  the  court  may  declare  it  void  and  set  it  aside  and 
order  such  restitution  and  attempt  to  place  the  par- 
ties in  or  as  near  to  their  original  positions  as  they 


386  RAILROAD  BONDS  AND  NOTES 

occupied  before  the  transaction  was  consummated, 
as  the  circumstances  of  the  case  permit. 

Parties  to  the  agreement  bound  by  its  terms ;  must 
deposit  bonds;  must  pay  share  of  expenses, 
etc. ;  when  such  expenses  are  not  paid ;  parties 
avoiding  liability  under  agreement;  abandon- 
ment. 

Each  party  to  the  agreement  is  usually  bound  by 
all  its  terms  and  is  entitled  to  all  its  benefits.  Ac- 
cordingly, when  so  bound,  he  must  comply  with  all 
its  requirements  as  to  the  deposit  or  delivery  of  his 
bonds  (if  a  bondholder)  and  shall,  when  requested 
by  the  committee,  execute  such  necessary  transfers, 
powers  of  attorney,  or  other  documents  as  the  com- 
mittee reasonably  may  require  to  enable  it  to  use  the 
deposited  bonds  according  to  the  terms  of  the  reor- 
ganization agreement  or  the  plan. 

Each  party  to  the  agreement  must  pay  his  share  of 
the  expenses  of  the  reorganization,  which  includes  the 
compensation  of  the  committee  and  such  other  assess- 
ments as  the  agreement  or  the  plan  shall  specify. 

Should  the  parties  to  the  agreement  fail  to  pay  their 
proportion  of  the  expenses  of  the  reorganization,  the 
committee  is  entitled  to  withdraw  and  refuse  to  pro- 
ceed. Should  the  property  of  the  insolvent  road  have 
already  been  purchased,  the  court  will  order  it  sold 
again  and  any  deficiency  on  the  resale  will  be  charged 
against  the  parties  to  the  agreement  proportionately. 


REORGANIZATION  OF  THE  RAILROAD      387 

As  the  agreement  for  reorganization  is  a  contract, 
each  party  to  it  is  bound  by  all  its  terms  and  must  do 
all  that  it  declares  he  shall.  He  can  only  avoid  lia- 
bility by  showing  that  he  was  induced  illegally  to  be- 
come a  party  to  it,  as  by  fraud ;  or  he  may  be  relieved 
from  further  liability  by  withdrawing  from  the 
agreement  when  the  agreement  itself  permits  this. 

Should  the  committee  abandon  the  reorganization, 
it  relieves  the  other  parties  to  it  from  further  liabil- 
ity under  it.  They  then  stand  upon  their  original 
rights  and  each  is  entitled  to  his  proportionate  share 
of  the  proceeds  of  the  sale  of  the  property  covered  by 
his  mortgage. 

The  abandonment  of  the  reorganization  by  the 
committee  or  the  withdrawal  from  it  by  the  parties 
relieves  the  latter  from  further  liability  from  that 
time  on;  but  as  to  obligations  already  incurred  before 
the  committee  abandoned  the  reorganization  or 
before  his  withdrawal,  each  party  continues  liable. 

Should  the  committee  abandon  the  reorganization, 
the  court  may,  under  some  circumstances,  declare 
that  it  has  lost  its  right  to  compensation. 

Withdrawing  from  the  agreement;  surrender  of 
certificates ;  payment  of  expenses  and  charges ; 
return  of  securities;  limitation  of  time. 

It  was  just  seen  that  each  party  is  usually  bound 
by  the  terms  of  the  agreement  and  usually  may  not 
avoid  his  responsibility  under  it  and  withdraw,  unless 


388  RAILROAD  BONDS  AND  NOTES 

the  agreement  specifically  provides  that  he  may  do  so. 
In  making  a  provision  of  this  kind  the  agreement,  at 
the  same  time,  regulates  such  withdrawal.  Agree- 
ments for  reorganization  usually  do  provide  for  cir- 
cumstances and  conditions  that  may  arise  when  it 
would  not  be  fair  to  ask  the  parties  to  proceed  further 
should  they  not  be  in  harmony  with  the  course  being 
then  pursued;  and  therefore,  they  contain  provisions 
under  which  such  parties  are  given  an  opportunity  to 
withdraw.  This  is  usually  when  the  plan  is  sub- 
mitted and  not  approved  by  them,  or  the  agreement 
or  the  plan  is  changed  against  the  objections  of  such 
parties.  If  the  committee  is  not  bound,  the  deposi- 
tors are  not,  and  may  withdraw  without  permission. 
The  privilege  to  withdraw  from  the  reorganiza- 
tion is  granted  only  upon  the  condition  that  the  party 
withdrawing  shall  surrender  his  certificate  of  deposit 
to  the  depositary,  endorsed  in  blank,  and  with  such 
other  assignments,  transfers,  or  powers,  as  may  be 
required,  and  thereupon  he  shall  receive  in  return  the 
securities  represented  by  his  certificate ;  and  also  that 
he  shall  pay  such  sums  as  may  be  charged  against 
the  securities  represented  by  that  certificate.  These 
charges  are  usually  the  amount,  with  interest,  of  any 
interest  that  may  have  been  advanced  by  the  commit- 
tee on  the  securities  to  be  withdrawn  and  such  sums 
as  the  committee  may  fix  as  a  fair  pro  rata  contribu- 
tion toward  the  expenses  of  the  reorganization  and 
its  own  compensation.  The  committee  is  entitled  to 


REORGANIZATION  OF  THE  RAILROAD      389 

require  as  a  further  condition  of  withdrawal  that  the 
party  withdrawing  shall  pay  its  proportionate  share 
of  any  moneys  the  committee  may  have  advanced  in 
the  course  of  the  reorganization  for  purposes  other 
than  its  own  expenses  and  compensation. 

The  committee  may  also  require  that  the  with- 
drawing party  shall  pay  his  proportionate  share  of 
such  sums  as  the  committee  may  require  to  be  held  by 
the  depositary  to  indemnify  it  (the  committee) 
against  any  obligation  it  may  have  incurred  in  the 
course  of  the  reorganization.  The  amount  of  this 
sum  is  fixed  by  the  committee ;  but  it  is  usually  pro- 
vided that  it  shall  not  exceed  one  per  centum  of  the 
face  amount  of  each  bond,  or  note,  or  other  obliga- 
tion. 

The  withdrawing  party,  when  paying  his  propor- 
tionate share  of  the  moneys  paid  out  by  the  commit- 
tee or  as  indemnity  against  obligations  incurred  by 
it,  is  given  a  certificate  or  other  written  evidence  of 
his  share  or  interest  in  those  moneys.  This  certifi- 
cate is  in  such  form  as  the  committee  shall  prescribe. 
Should  it  eventually  transpire  that  the  amount  so 
withheld  is  not  necessary  or  more  than  necessary  the 
party  depositing  or  advancing  it  is  entitled  to  its 
return  or  to  his  proportionate  share  of  the  excess. 

Upon  paying  all  charges  against  his  securities  and 
surrendering  his  certificate  of  deposit,  securities  rep- 
resented by  such  certificate  of  deposit  are  returned  to 
the  withdrawing  party  and  he  is  regarded  as  having 


390  RAILROAD  BONDS  AND  NOTES 

withdrawn  from  the  agreement  and  the  reorganiza- 
tion proceedings,  and  is  no  longer  bound  by  them, 
nor  entitled  to  any  of  their  benefits. 

The  time  within  which  a  party  may  withdraw 
from  an  agreement  for  reorganization  is  usually  lim- 
ited in  the  agreement  itself.  Should  he  not  with- 
draw within  the  specified  time,  he  is  presumed  to 
have  consented  to  the  plan  or  to  the  changes  in  the 
agreement  or  the  plan,  and  is  bound  by  their  terms  as 
so  changed.  He  has  then  lost  the  right  to  withdraw. 

It  is  sometimes  provided  that  the  committee  may 
withdraw  a  proposed  plan,  or  changes  to  a  plan  or 
agreement,  when  it  sees  that  too  many  of  the  parties 
are  objecting  and  withdrawing.  When  the  commit- 
tee withdraws  the  plan  or  the  changes  in  the  plan  or 
in  the  agreement,  the  rights  of  the  parties  to  the 
agreement  to  withdraw  from  it  immediately  cease. 
Those  who  have  not  availed  themselves  of  the  privi- 
lege have  lost  it  unless  it  be  given  again  with  relation 
to  some  other  plan  or  changes. 

Termination  of  the  agreement;  by  completing  re- 
organization ;  committee  may  terminate ;  court 
may  declare  agreement  abandoned;  rights  of 
parties  when  terminated  by  court  or  com- 
mittee. 

When  the  reorganization  has  been  carried  out  the 
agreement  is  terminated  because  it  has  been  fully 
performed  and  there  is  nothing  further  to  do. 


REORGANIZATION  OF  THE  RAILROAD      391 

However,  at  any  intermediate  stage  of  the  reor- 
ganization, the  committee  is  quite  generally  em- 
powered by  the  agreement  to  terminate  it  whenever 
it  shall  consider  such  a  course  best  or  advisable.  In 
the  absence  of  such  a  power  in  the  committee,  the 
agreement  must  continue  in  force  until  it  is  per- 
formed and  the  reorganization  carried  out;  or  until 
it  is  declared  abandoned  by  the  court;  or  all  the  par- 
ties by  mutual  consent  dissolve  the  agreement  and 
adjust  matters  to  their  mutual  satisfaction  among 
themselves. 

Should  the  committee  abandon  its  task,  it  relieves 
the  other  parties  to  the  agreement  from  performing 
their  obligations,  and  they  may  ask  the  court  to  de- 
clare the  agreement  abandoned  and  terminated. 

Should  the  committee,  under  its  power  to  do  so, 
declare  the  agreement  terminated,  or  should  the  court 
so  declare  it,  the  parties  are  relieved  from  further 
obligation  under  it;  and  they  should  then  be  put  in 
the  positions  they  were  in  before  the  reorganization 
was  commenced,  so  far  as  the  condition  of  affairs  and 
the  situation  of  the  parties  and  the  property  permits. 
Accordingly,  parties  who  have  deposited  their  securi- 
ties may  surrender  their  certificates  of  deposit  to  the 
depositary  and  receive  in  return  the  securities  repre- 
sented by  these  certificates,  upon  complying  with  the 
terms  imposed  by  the  court  or  the  committee,  as  the 
case  may  be.  These  terms  usually  are  that  the  per- 
son withdrawing  his  securities  shall  return  the 


392  RAILROAD  BONDS  AND  NOTES 

amount  (with  interest)  that  may  have  been  ad- 
vanced by  the  committee  as  interest  upon  the  securi- 
ties he  withdraws ;  and  that  he  shall  pay  his  propor- 
tionate share  of  the  expenses  of  the  committee;  and 
the  committee  may  also  require  that  the  party  pay 
at  that  time  his  proportionate  share  of  such  sums  as 
the  committee  may  have  expended  in  the  course  of 
the  reorganization,  for  purposes  other  than  its 
expenses  and  compensation,  such  as  discharging 
prior  liens  or  other  payments  of  like  nature  necessary 
or  deemed  advisable  to  protect  the  securities  de- 
posited; and  too,  the  withdrawing  party  shall  pay 
such  sums  as  the  committee  shall  require  to  be  held 
by  the  depositary  to  indemnify  it  (the  committee) 
against  any  obligation  it  may  have  incurred  under 
the  agreement. 

Should  the  committee  have  abandoned  the  agree- 
ment unreasonably,  or  should  it  have  acted  wilfully 
neglectful,  the  court  may  declare  that  it  has  for- 
feited its  right  to  compensation,  should  the  situation 
justify  such  a  decision. 

Upon  making  payments  of  sums  other  than  the 
return  of  interest  and  the  expenses  and  compensation 
of  the  committee,  the  party  receives  a  certificate  or 
other  writing  or  evidence  of  such  moneys  so  deposited 
and  advanced.  Should  the  amount  so  held  be  event- 
ually found  not  to  be  necessary  or  to  be  more  than  is 
necessary,  the  party  so  advancing  or  depositing  this 


393 

sum  is  entitled  to  its  return  or  to  the  return  of  his 
proportionate  share  of  the  excess,  as  the  case  may 
be. 

\ 

Expenses  of  reorganization;  charged  against  de- 
posited securities;  payment  as  condition  of 
right  to  receive  securities  of  new  corporation. 

The  parties  to  the  agreement  in  whose  behalf  the 
committee  acts  must  defray  the  expenses  of  the  reor- 
ganization. Such  expenses  include  the  compensa- 
tion of  the  committee,  proper  fees  for  legal  counsel, 
and  other  necessary  outlays  incurred  in  the  course  of 
carrying  out  their  duties ;  including  the  compensation 
and  disbursements  of  such  managers,  sub-commit- 
tees, or  other  representatives  that  may  have  been 
properly  employed  or  appointed.  Any  loss  the  com- 
mittee or  depositary  may  suffer  in  carrying  out  the 
reorganization  are  properly  charged  as  expenses, 
where  such  loss  was  not  caused  by  bad  faith. 

It  is  proper  that  the  agreement  should  provide  the 
manner  for  meeting  these  expenses.  The  parties  to 
the  agreement  are  bound  by  any  provision  for  the 
expenses  of  the  reorganization  that  the  agreement  or 
the  plan  may  contain. 

Should  the  agreement  or  the  plan  not  provide  for 
the  payment  of  the  expenses  of  the  committee  or  of 
the  reorganization,  the  law  declares  that  each  party 
participating  shall  pay  his  proportionate  share.  The 


394  RAILROAD  BONDS  AND  NOTES 

agreements  or  the  plans  usually  make  provisions  to 
the  same  effect.  See  Withdrawing  from  agreement; 
payment  of  expenses  and  charges.  Page  387. 

The  parties  to  the  agreement  are  not  entitled  to 
their  stock  or  other  securities  in  the  new  corporation 
until  they  pay  their  proportionate  share  of  the  ex- 
penses of  the  reorganization  and  of  such  other 
moneys  as  are  properly  charged  against  them. 

The  new  corporation;  distinct  legal  body  from  old 
corporation ;  succeeding  to  franchises ;  name  of 
new  corporation;  distinction  between  fran- 
chises to  operate  and  franchise  to  exist  as  a 
corporation. 

The  new  corporation,  organized  by  the  committee 
or  the  other  purchasers  at  the  foreclosure  sale,  is  a 
separate  and  distinct  legal  body  from  the  old  insol- 
vent road.  Sometimes  the  reorganization  is  per- 
fected without  selling  the  property  of  the  road  at 
foreclosure,  but  by  a  general  readjustment  of  its 
affairs;  then  the  old  corporation  continues  in  opera- 
tion and  no  new  one  is  formed. 

It  has  been  held  that  the  purchaser  at  the  fore- 
closure sale  of  an  insolvent  railroad  need  not  incor- 
porate to  operate  the  road.  An  individual  may  pur- 
chase the  road  and  operate  it  as  an  individual,  or 
may  transfer  it  to  others.  The  universal  rule,  how- 
ever, is  for  the  purchasers  at  the  foreclosure  sale  to 
incorporate  or  to  convey  the  property  to  a  corporation 


REORGANIZATION  OF  THE  RAILROAD     395 

purposely  formed  to  take  over  the  property  and 
operate  the  road. 

Should  the  franchise  to  operate  the  road  be  in- 
cluded in  the  sale,  as  it  quite  generally  is,  the  new 
corporation  succeeds  to  all  the  powers  and  the  rights 
that  the  old  corporation  had  to  operate  the  road.  In 
succeeding  to  these  franchises  and  powers  and  rights, 
the  new  corporation  must  assume  the  public  obliga- 
tions that  the  old  corporation  was  charged  with,  and 
must  maintain  and  keep  the  railroad  in  operation  as 
a  public  highway  for  the  transportation  of  persons 
and  property  and  must  carry  out  all  regulations  im- 
posed by  the  State  or  governmental  commissions  with 
relation  to  the  exercise  of  such  franchises. 

The  new  corporation  may  use  the  name  of  the  old 
one,  unless  some  law  forbids  it.  However,  the  fact 
that  the  old  corporation  has  been  stripped  of  all  its 
property  by  the  foreclosure  does  not  affect  its  con- 
tinued existence  as  a  corporation,  unless  the  law  of 
the  State  under  which  it  was  organized  declares  that 
the  sale  of  its  property  at  foreclosure  shall  dissolve 
the  corporation.  In  the  absence  of  such  a  statute, 
the  old  insolvent  corporation  continues  and  under  its 
old  name.  While  the  old  corporation  may  thus  con- 
tinue, it  does  so  usually  for  the  purposes  only  of 
winding  up  its  affairs;  it  has  no  power  any  longer  to 
operate  the  road,  as  its  franchises  to  do  so  have  been 
sold  and  are  now  held  by  the  new  corporation. 

In  those  cases  where  the  old  corporation  continues 


396  RAILROAD  BONDS  AND  NOTES 

and  uses  its  name,  the  new  corporation  takes  a  name 
similar,  substituting  usually  only  the  word  "rail- 
way" for  "railroad,"  or  vice  versa. 

It  may  be  opportune  to  call  attention  again  to  the 
distinction  between  the  franchise  to  operate  the  rail- 
road and  the  franchise  to  exist  as  a  corporation. 
The  old  corporation  continues  in  existence  notwith- 
standing that  all  its  property  has  been  sold;  it  con- 
tinues in  existence  until  it  has  been  legally  dissolved 
by  a  proceeding  instituted  by  the  Attorney  General 
acting  for  the  sovereign  power,  the  State,  that  cre- 
ated it. 

The  only  power  that  can  take  away  the  life  of  a 
corporation  is  the  power  that  gave  it,  i.  e.,  the  State. 
The  right  to  be  a  corporation  is  acquired  by  compli- 
ance with  certain  formal  requirements  of  statutes. 
The  statutes  of  some  States  declare  that  the  pur- 
chaser at  the  foreclosure  sale  need  not  comply  with 
these  formal  requirements  but  shall  become  a  corpo- 
ration by  reason  of  such  purchase.  The  new  cor- 
poration is  created  therefore  either  by  formal  in- 
corporation or  by  reason  of  the  purchase  at  the 
foreclosure  sale. 

If  the  franchise  to  operate  is  not  included  in  the 
sale  or  does  not  pass  to  the  purchaser  for  any  reason, 
then  the  mere  physical  property  only  passes  to  the 
new  corporation  without  the  right  to  operate  it  as  a 
railroad.  Should  the  franchise  to  operate  be  in- 
cluded in  the  sale  and  pass  to  the  new  corporation, 


REORGANIZATION  OF  THE  RAILROAD     397 

it  is  owned  and  used  by  it  the  same  as  any  other 
property.  This  new  corporation  then  holds  the 
property  purchased  at  the  foreclosure  sale  and  with 
it  also  possesses  the  right  to  operate  it  as  a  railroad. 
It  is  then  in  a  position  to  do  business  with  this  prop- 
erty so  acquired,  including  the  right  to  operate  it, 
and,  accordingly,  proceeds  to  do  business  with  such 
moneys  as  it  may  raise  by  one  or  more  of  the  usual 
methods,  i.  e.,  by  assessing  the  parties  to  the  reorgan- 
ization, by  sale  of  its  stock,  bonds,  notes,  or  other 
securities,  and  such  credit  as  may  be  given  it. 

New  corporation  bound  to  issue  stock,  bonds,  etc., 
according  to  agreement  and  plan;  rights  of 
parties  to  agreement  to  securities  of  new  cor- 
poration; when  such  securities  must  issue; 
five  years'  rule ;  voting  trust. 

The  new  corporation  is  bound  to  issue  to  the  par- 
ties to  the  agreement  such  stock,  bonds  or  other 
securities  as  the  agreement  or  the  plan  declares  it 
shall.  And  the  court  will  compel  it  to  carry  out 
completely  the  terms  of  the  agreement  or  the  plan 
in  this  regard.  True,  the  new  corporation  never 
signed  the  agreement  nor  was  it  a  party  to  it  or  to  the 
plan  that  is  sought  to  be  enforced  against  it.  It 
was  not  in  existence  at  that  time.  But  it  came  into 
existence  as  a  result  of  the  agreement  and  the  plan. 
The  law,  accordingly,  will  read  the  agreement  and 
the  plan  for  reorganization  into  the  charter  of  the 


398  RAILROAD  BONDS  AND  NOTES 

new  corporation  and  compel  it  to  enforce  its  pro- 
visions in  this  respect. 

Should  the  reorganization  have  been  carried  out 
by  the  bondholders  under  the  foreclosed  mortgage 
alone,  and  the  plan  contemplates  the  distribution  of 
the  capital  stock  of  the  new  corporation  among  them 
alone,  each  is  entitled  to  receive  his  proportionate 
share  of  the  stock  issued.  The  stock  of  the  new  cor- 
poration when  issued  to  them  represents  their  owner- 
ship in  the  property  that  their  bonds  purchased. 

Should  the  new  corporation  be  capitalized  for 
more  than  the  amount  for  which  the  property  was 
purchased  at  the  foreclosure  sale,  with  the  object  of 
raising  money  by  the  sale  of  the  additional  stock, 
then  the  share  of  the  participating  bondholder  is  con- 
fined to  his  proportionate  share  of  the  capital  stock 
that  represents  the  amount  paid  at  the  sale. 

Bondholders  do  not  always  receive  stock  to  repre- 
sent their  interests  in  the  new  corporation.  Under 
some  plans  of  reorganization  they  receive  in  ex- 
change for  their  bonds,  or  their  interest  in  the  prop- 
erty purchased  at  the  foreclosure,  other  bonds  or 
notes  of  the  new  corporation.  This  is  when  stock- 
holders of  the  old  corporation  join  with  the  bond- 
holders in  the  reorganization.  Then  the  stockhold- 
ers receive  the  stock  of  the  new  corporation  upon 
paying  in  cash  for  it.  The  bondholders  may  also 
take  stock  in  payment  in  whole  or  part  of  their 
bonds.  Each  reorganization  depends  upon  the  situa- 


REORGANIZATION  OF  THE  RAILROAD     399 

tion  that  confronts  the  committee,  and  each  plan  is 
made  with  the  object  of  putting  the  new  corporation 
upon  a  financial  basis  that  will  enable  it  to  operate 
profitably,  and  at  the  same  time  satisfy,  so  far  as  the 
situation  permits,  all  the  persons  and  interests  par- 
ticipating in  the  reorganization. 

The  agreement  or  the  plan  may  designate  the  time 
within  which  the  reorganization  shall  be  completed 
and  the  stock  or  other  securities  of  the  new  corpora- 
tion shall  be  issued  and  distributed  to  the  parties 
entitled  to  them.  It  is  quite  common  for  the  agree- 
ment or  the  plan  to  limit  the  period  to  five  years 
within  which  the  reorganization  shall  be  perfected 
and  the  securities  of  the  new  corporation  distributed 
or  the  deposited  securities  returned.  This  is  done 
to  comply  with  the  rule  of  the  Committee  on  Stock 
List  of  the  New  York  Stock  Exchange. 

The  reorganization  agreement  may  create  a  voting 
trust  by  which  the  committee  or  others  are  appointed 
voting  trustees  for  a  specified  period;  in  some  States 
limited  to  five  years.  By  this  accumulation  of  the 
voting  rights  into  the  hands  of  the  voting  trustees,  on 
the  bonds  deposited  and  on  the  securities  of  the  new 
corporation,  the  power  to  control  the  affairs  of  the 
reorganization  and  the  policies  of  the  new  corpora- 
tion is  concentrated.  While  such  voting  trust  is  in 
force  the  bondholders  have  no  vote  on  their  deposited 
or  new  securities,  but  are  bound  by  the  vote  of  their 
voting  trustees,  when  the  latter  act  within  the  scope 


400  RAILROAD  BONDS  AND  NOTES 

of  the  powers  conferred  on  them.  Such  voting  trust, 
among  other  powers,  may  confer  on  such  voting  trus- 
tees the  power  to  determine  when  the  capital  stock, 
bonds,  or  other  securities  of  the  new  corporation  shall 
be  issued  and  distributed. 

New  corporation  may  take  property  free  from  all 
liens  against  it ;  may  take  subject  to  such  liens ; 
or  some  of  them ;  other  debts  and  contracts  of 
the  old  corporation. 

Whether  or  not  the  new  corporation  shall  take  the 
property  of  the  insolvent  road  purchased  at  the  fore- 
closure sale,  or  otherwise  acquired,  free  from  the 
mortgages  or  other  liens  against  it  having  priority 
over  the  mortgage  that  was  foreclosed,  depends  upon 
the  order  of  the  court  ordering  the  property  sold. 

This  decree,  or  order  of  the  court,  may  direct  that 
the  property  shall  be  sold  subject  to  all  mortgages  or 
other  liens  having  priority  over  the  foreclosed  mort- 
gage. In  such  case  the  new  corporation  that  pur- 
chases this  property  must  pay  these  prior  mortgages 
or  other  liens,  so  far  as  such  property  against  which 
they  are  charged  will  do  so.  It  has  no  liability  for 
these  payments  beyond  the  value  of  the  property 
against  which  they  are  charged.  However,  should 
the  new  corporation  expressly  assume  certain  debts 
as  part  of  the  purchase  price,  it  must  pay  such  debts 
without  regard  to  the  value  of  the  property  it  takes 
over.  By  thus  assuming  a  debt  as  part  of  the  pur- 


REORGANIZATION  OF  THE  RAILROAD      401 

chase  price,  the  new  corporation  makes  it  its  own 
obligation. 

The  decree  of  the  court  may  order  that  the  prop- 
erty be  sold  free  from  such  prior  mortgages  or  other 
liens  and  that  they  be  charged  against  the  proceeds 
of  the  sale.  These  respective  liens  in  this  way  are 
transferred  from  the  property  to  the  proceeds.  The 
new  corporation  then  takes  the  property  free  and 
clear  of  such  mortgages,  other  liens  and  claims.  Of 
course  the  purchase  price  in  each  case  is  different. 
When  sold  subject  to  prior  mortgages  and  other  liens 
only  the  equity  in  the  property  is  actually  paid. 
When  sold  free  and  clear  of  such  prior  mortgages 
and  other  liens,  then  the  full  purchase  price  is  actu- 
ally sold.  By  equity  is  meant,  in  the  instance  under 
discussion,  what  is  left  after  the  amount  of  all  the 
prior  mortgages  and  other  liens  are  deducted  from 
the  value  of  the  property  in  question. 

In  the  absence  of  any  understanding  to  the  con- 
trary the  purchaser  at  the  foreclosure  sale  takes  the 
property  free  from  all  interests  or  claims  of  the  in- 
solvent railroad  company  itself,  its  stockholders,  its 
unsecured  or  general  creditors,  and  also  of  its  cred- 
itors who  were  secured  by  mortgage  or  other  liens 
that  attached  to  the  property  later  in  point  of  time 
than  that  of  the  foreclosed  mortgage.  As  to  all  these 
the  foreclosure  cuts  off  their  rights  in  the  property. 
As  to  those  whose  mortgages  or  other  liens  have  pri- 
ority over  the  foreclosed  mortgage,  the  foreclosure 


402  RAILROAD  BONDS  AND  NOTES 

does  not  affect  their  rights  in  any  way.  They  are 
entitled  to  be  paid  in  full  out  of  the  property  against 
which  they  are  charged  or  out  of  its  proceeds,  accord- 
ing to  their  respective  ranks  and  priorities,  before  the 
bonds  under  the  foreclosed  mortgage  receive  any- 
thing. Therefore  the  decree  of  the  court  provides 
for  them  by  either  continuing  their  liens  against  the 
property  in  the  hands  of  the  purchaser  or  by  selling 
the  property  free  from  their  liens  and  transferring 
such  liens  against  the  proceeds  of  sale. 

Contracts  made  by  the  old  corporation  are  not 
binding  on  the  new  corporation  and  it  is  in  no  way 
affected  by  them.  But  should  the  reorganization  be 
carried  out  so  that  no  new  corporation  is  formed  but 
the  old  company  is  continued  in  a  readjusted  form, 
then  the  contracts  that  it  previously  made  continue 
against  it,  as  there  is  no  change  in  its  corporate  exist- 
ence. 

However,  should  the  new  corporation  adopt  a  con- 
tract made  by  the  old  corporation,  or  accept  any  ben- 
efits under  it  and  thus  adopt  it,  it  becomes  liable 
on  it. 

New  corporation  not  liable  for  contracts  or  debts 
of  the  receiver ;  exceptions. 

The  new  corporation  takes  the  property  and  fran- 
chises purchased  at  the  foreclosure  sale  free  from  all 
claims  for  the  debts  and  contracts  that  the  receiver 


REORGANIZATION  OF  THE  RAILROAD     403 

incurred,  unless  a  statute  or  an  order  of  the  court 
charges  such  claims  against  such  property. 

Such  statute  or  order  of  the  court  may  make  the 
debts  of  the  receiver,  or  certain  of  them,  a  condition 
of  the  sale,  by  either  selling  the  property  free  from 
them  and  charging  them  against  the  proceeds,  or  by 
directing  that  the  property  be  sold  subject  to  their 
lien,  whereupon  the  purchaser  takes  the  property 
charged  with  their  payment  so  far  as  the  property 
itself  will  do  so,  there  being  no  liability  beyond  that. 
Or  such  statute  or  order  of  the  court  may  declare 
that  the  purchaser  shall  assume  the  payment  of  these 
claims  as  part  of  the  purchase  price ;  and  he  then  be- 
comes personally  liable  for  such  debts  so  assumed, 
without  regard  to  the  value  of  the  property. 

Receiver's  certificates  are,  as  a  rule,  made  a  lien, 
superior  to  that  of  the  foreclosed  mortgage,  against 
the  property  and  franchise  to  be  sold,  The  certifi- 
cates are  then  paid  in  full  out  of  the  proceeds  of 
the  sale  of  the  property  before  the  holders  of  the 
bonds  under  the  foreclosed  mortgage  receive  any- 
thing. The  court  may  order  the  property  sold  sub- 
ject to  the  lien  of  the  certificates,  whereupon  the 
purchaser  becomes  liable  for  their  payment  to  the  ex- 
tent of  the  value  of  the  property  against  which  they 
are  a  lien.  Or  the  property  may  be  sold  free  and 
clear  of  the  certificates,  and  their  lien  transferred  to 
the  proceeds  of  the  sale.  Sometimes  the  property  is 


404  RAILROAD  BONDS  AND  NOTES 

sold  and  as  part  of  the  purchase  price  the  new  cor- 
poration undertakes  to  pay  the  receiver's  certificates, 
thus  making  them  its  own  obligation. 

The  new  corporation  is  not  liable  for  damages  for 
claims  for  injuries  to  persons  or  to  property,  com- 
mitted by  the  receiver  or  his  employees  in  the  opera- 
tion of  the  road  during  the  receivership. 

The  new  corporation  is  not  liable  for  any  negli- 
gence in  the  operation  of  the  road  until  it  takes  over 
and  assumes  control.  Should  the  receiver  continue 
to  operate  the  road  after  the  sale,  at  the  request  of 
the  committee,  and  after  title  to  the  property  has 
passed  to  the  purchasing  committee  or  to  the  corpora- 
tion it  represents,  then  such  new  corporation  shall  be 
liable  for  all  claims  for  damages  to  persons  or  prop- 
erty during  that  period. 


INDEX 


Abandonment  of  plan  of  reor- 
ganization after  adoption, 
rights  of  depositors,  344, 
364-365 

Abandonment  of  reorganization, 
rights  of  parties,  343-345, 
386-387,  390-393 

Accounting,     by     reorganization 

committee,  378,  382 
receiver,   220-221 

Acts  of  trustee  binding  on 
bondholders,  121 

Adjournment  of  foreclosure 
sale,  181-182 

Adopting  plan,  power  of  reor- 
ganization committee,  372 

After  acquired  property  clause, 
83,  85-86 

Agreement    for    reorganization, 
rights   of   bondholders   to 
examine,  342-343 
synopsis  of,  349-352 

Altered  bonds,  notes  or  coupons, 

30-31. 

Amount  of  issue,  69-72 
Ancillary  receiverships,  195-197 
Appraisement  laws,   184 

waiver  of,  88 
Approval    or    rejection   of   plan 

for    reorganization,    360- 

364 
Approval  or  rejection  of  changes 

in  plan,   365-368 
Assented  bonds,  325 
Assented  income  bonds,  334 
Assessments      of      stockholders, 

a  form  of  reorganization, 

335-337 

Assents  to  plan  for  reorganiza- 
tion, 360-364 
Assignment  in  blank,  25 
Assumed  bonds,   309-310 


Attaching   creditors,    193-195 
Attachments      and      executions, 

253-254 

Attitude  of  courts,  toward  com- 
binations  to   purchase   at 
foreclosure,  171 
toward  railroad  bonds,  62,  117 
toward  receiverships,  191-192 
toward    reorganizations,    340- 

342 

toward  trustees,  118-119,  124 
Avoiding    liability   under    reor- 
ganization         agreement, 
386-387 


Betterments,   313 

Blank  space  for  name  of  payee, 

25 
Blanket    mortgage    bonds,    269- 

271 

Bona  fide  holders,  of  bonds  or 
notes,  23-28 

of  coupons,  46 
Bond  of  receiver,  192-193 
Bondholders,      agreements      be- 
tween, 349 

bound  by  acts  of  reorganiza- 
tion committee,  385 

bound  by  decisions  of  courts, 
126-128 

consolidation  affecting  the 
rights  of,  289-290 

depositing  bonds  under  reor- 
ganization agreement,  351, 
386-387 

expenses  of  reorganization 
when  paid  by,  386-387 

may  appear  in  litigation,  126- 
128,  164 

may  control  remedies,  147, 
164-166 


405 


INDEX 


Bondholders — continued. 

may  litigate  instead  of  trus- 
tee, 127-129,  166 

may  lose  rights  to  set  fore- 
closure sale  aside,  183- 
184 

option  to  declare  principal 
sum  due,  150-151 

purchasing  road  with  bonds, 
185,  383-385 

reorganization  alone  or  with 
other  creditors  or  stock- 
holders, 346-349 

reorganization  committee,  acts 
of  binding  on,  385 

stockholders  and,  compared, 
15-16 

suing  on  individual  holdings, 
129-131 

terms  of  reorganization  agree- 
ment affecting,  386-387 
Bonds,   accepted   in   payment  of 
purchase,    185 

consents  and  permission  to 
issue,  68-69 

convertible  into  capital  stock, 
105-110 

deposited  under  reorganiza- 
tion, how  deposited,  352- 

353 
use  of,  352-353 

described,  8-n 

dishonor  of,  42 

execution  of,  13 

excess  issue,   19 

form  of,  72-75 

new  corporation,  after  reor- 
ganization must  issue, 
397-400 

notes  and,  compared,  10 

numbered,  241-243 

over-issued,  243 

purchasing    road    with,    383- 

385 

registered,  described,  14, 
registration  of,  48-50 

reissued,  exchanged,  substi- 
tuted, 243-244 

series,  240-241 

statutes  of  limitation,  46-48 


Bonds — continued, 
temporary,  12 

terms    of,    binding    on    bond- 
holders, 16-18 
transfer  of,  13-14 
use  of,  to  purchase  road,  383- 

3?5 

violation  of  power  to  issue,  19 
Branch  lines,  financing  of,  283- 

286 
receivership   of,    197-198 


Calling  bonds  in,  98-100 
Cancellation  of  coupons,  38,  92- 

93,  261-262 
Car   trust   certificates   or  bonds, 

316-323 

Certificates      of      deposit,      de- 
scribed, 353-354 
do  not  draw  interest,  355 
surrender  of,  387-390 
transfer      and      negotiability, 

353-356 

Changes   in   agreement,   365-368 
power  of  committee  to  make, 

365-368,   370^372 
plan  for   reorganization,   358- 

.  359,.  365-368 

Classification  of  bonds,  21-22 
Clear  bonds,  32-33 
Closed    mortgages,    69-72,    239- 

241 
Collateral,   direct  obligation   or, 

76 

mixed,  278 
trust     mortgages,     bonds     or 

notes,  277-286 

Collection  of  coupons,  36-37 
Combinations     to     purchase     at 

foreclosure,  170-172,  183 
Committee ;    see   Reorganization 

committee 
Compensation,  of  receiver,  223- 

224 
of    reorganization    committee, 

392,  393 

of  trustee,  141-142 
Condemnation     proceedings,     to 
acquire  right  of  way,  257 


INDEX 


407 


Condition  of  insolvent  road,   5- 

.  7,  234-236 

Conditional  sales,  255-257 
Consents     and     permission,     to 
issue    bonds     and     mort- 
gage,   68-69 
to  receivership,   192-193,   198- 

199 

Consolidated  bonds,  287 
Consolidated    roads,    bonds    of, 

286-292 

liability   for    debts    and    con- 
tracts       of        constituent 
roads,   286-292 
stock  of,  289 
Consolidation,     bonds     resulting 

from,  274-277 

conversion  into  capital  stock, 
affected  by,  107-108,  290- 
291 

how  carried  out,  288-289 
rights     of     bondholders,     af- 
fected by,  289-290 
Constituent     roads,     bonds     of, 

286-292 
Construction      company,      bonds 

from,   314-316 

claims  for  original,  250-252 
bonds  for,  71 
Construing     plans,      power     of 

committee,   370-372 
Contracts,     debts     of     insolvent 
road,    affecting   new   cor- 
poration, 402-404 
debts    of    insolvent    road,    in 
connection   with   receiver- 
ship, 203-206 

Control  of  bonds  deposited  un- 
der reorganization  agree- 
ment, 352-356 

Control      of     subsidiary     road, 
bonds      resulting      there- 
from, 274-277 
Conversion  parity,  109 
Convertible    bonds    into   capital 

stock,  105-110 
affected  by  consolidation,  107- 

108,  290-291 

Convertible  collateral  trust 
bonds  or  notes,  279 


Convertible  or  interchangeable 
bonds,  53-55 

Converting  registered  into  cou- 
pon bond,  50-52 

Cooperation  with  other  reor- 
ganizations, 372-373 

Corporation  organized  to  take 
over  insolvent  road;  see 
New  Corporation 

Co-trustees,  122-123 

Counsel,  opinion  of  as  to  bond 
and  mortgage,  61-62 

Coupon  bonds,  converting  into 
from  registered  bonds, 
50-52 

generally,  31-32 
transfer,  32-33 

Couponholders,  relations  to  each 
other,  46 

Coupons,  bona  fide  holder  of,  46 
negotiable,     bond     registered, 

52-53 

cancellation     of,     38,     92-93, 
261-262 

collection  of,  36-37 

effect  of  payment,  38-40 

interest  on,  40-42 

invalid,  46 

meaning  of  word,  32 

overdue,  40-42 

payment  of,   37-38 

priorities       and       preferences 
among,  44-46,  260-262 

registered,  53 

security  for,  44-46 

severed,  34-36 

statutes  of  limitation,  46-48 
Court,  advising  receiver,  201 

advising  trustee,  135 
Creditors,  generally,  234-237 

on  equal  footing,  238 

receivership     affecting,     193- 

195 
Cumulative  income  bonds,   330- 

33i 

Current  income,  229-230,  247- 
248 

Damages  to  persons  or  prop- 
erty, 231,  260 


408 


INDEX 


Damage — continued, 
inflicted    during    receivership, 

209-210 

share  in  assets,  209,  231,  260 
Debenture  income  bonds,  330 
Debentures,  described,   11-12 
sharing  in   assets,  262-265 
Debts  and  contracts  of  insolvent 
road    in   relation   to   new 
corporation,  402-404 
Debts  and  expenditures  of  reor- 
ganization         committee, 
375-376 

Deed  of  trust,  or  mortgage,  pur- 
pose of,  56 

Default,  in  payment,  91 
on  purchase  of  road,  384 
under  mortgage,  58 
waiver  of,   152-153 
what  constitutes,   148 
Defective  mortgages,  66-67 

valid  bonds,  66 

Defectively  issued  bonds,   19-20 
Delegating    powers    by    trustee, 

123-124 
Deposit,  certificates  of,  transfer, 

negotiability,  353-356 
Deposited     bonds     under     reor- 
ganization,      power       of 
committee   over,    373-374 
use  of,  352-353 
Deposit   on    bid    on    foreclosure 

sale,    184-185 

Depositors'  agreement,  349 
Depreciation  in  value  of  securi- 
ties deposited  under  mort- 
gage,  81-82 

Description  of  mortgaged  prop- 
erty, 83-84 

Details,  of  receivership,  202 
of   reorganization,   368-370 
of  trusteeship,   134-135 
Development,  bonds  relating  to, 

312-314 
Direct  or  collateral  obligations, 

76 
Discharge      of      reorganization 

committee,   378-382 
Discretionary     powers,     of     re- 
ceiver, 202 


Discretionary  powers — cont. 
of    reorganization    committee, 

generally,   368-370 
with  relation  to  plan,  360- 

361 

of  trustee,  134-135 
Dishonor  of   bond,  40-42 
Displacing   lien   of   prior   mort- 
gage,   237-239,    246 
with  lien  for  taxes,  254-255 
Dissents      from      reorganization 

plan,   360-364 

Distribution  of  proceeds,  of 
operation  by  trustee,  156- 

157 
of    sale    by   trustee,    114-115, 

161-162 

Dividends  on  stock  deposited  un- 
der mortgage,  78 
Divisional   bonds,  292-293 
Divisions,  financing  of,  283-286 
foreclosing    against,    169-170 
Document    or    papers    necessary 

to   trusteeship,    88-89 
Duties,   of   receiver  while  oper- 
ating the  road,  200-202 
of    reorganization    committee, 

377-379 
of  trustee,   132-134 

Effect,  of  foreclosure  on  mort- 
gages and  other  claims, 
178-181 

of  payment  of  coupons,  can- 
cellation, 38-40 

of  receivership  on  existing 
rights  and  claims,  193- 

195 

of     trustee's     acts     on     bond- 
holders, 121 
Enforcing    the    mortgage,    in- 

"5 

Equipment  bonds,   323-324 

Equipment    trust    certificates    or 

bonds,   316-323 
Equity  of   redemption,   178-180 

what  it  is,  401 
Excess  issue,  69-72 
Exchanged  bonds,  244 

in  refunding,  101-105 


INDEX 


409 


Execution,  of  bonds,  13 

and  attachments,  253-254 
Exemption        and        redemption 

laws,  waiving  of,  88-89 
Expenditures,   and   debts   of   re- 
organization      committee, 
375-376 
by       receiver,       for       large 

amounts,  207-209 
generally,  206-207 
by  trustee,  142-144,   157-1  eg 
Expenses   of   receivership,  what 

are,  209 
of    reorganization    committee, 

375-376 
participating       bondholders 

liable  therefor,  386-387 
how  paid,  393-394 
of   trusteeship,    142-144,    157- 

158 
Extended  bonds  or  notes,   327- 

328 

Extension  bonds,  314 
financing  of,  283-286 

Face  value  paid,  28-29 

Filing  plan,  358-359 

Filing    or    recording   mortgage, 

64-66 
Fire    insurance    of    mortgaged 

property,   83-84 
First      consolidated      mortgage 

bonds,   287 

First  lien  bonds,  266-267 
First  mortgage  bonds,  first 
mortgage  consolidated 
bonds,  first  mortgage  col- 
lateral trust  bonds,  267- 
269 

Foreclosure,   146-147 
bondholders    instead    of   trus- 
tee may  bring,  164-166 
control   by   bondholders,    164- 

166 

divisional  mortgages,  169-170 
for  interest  only,  168 
lease  instead  of,  168-169 
minority  may  demand,  164 
postponing,      provisions      for, 
148-150 


Foreclosure — continued. 

procedure ,   outline    of,    162- 

163 

sale  under,  167-170 
trustee  prefers  to  bring,  185- 

186,   164-166 
Form  of  bond,  72-75 
Form  of  trustee's  certificate,  75 
Franchise,    to    exist    as    a    cor- 
poration,     61,      173-174, 
395-396 
to   operate    a    road,    173-174, 

395-396 
power    to    mortgage    same, 

59^62 

Fraud,   in   combination   to  pur- 
chase  at  foreclosure,   183 
in  foreclosure  sale,  182-184 
in  issue  of  bonds,  24 
Fund    realized    from    sale    by 
trustee,  114-115 

General   mortgage  bonds,   269- 

271 

General    or    unsecured    claims, 
affected  by  consolidation, 
288 
affected      by     reorganization, 

178-180 

share  in  assets,  227-229 
Gold  coin,  payment  in,  91 
Good  delivery,   14 
Good    faith,    of    purchaser    of 
bonds    and    coupons,    23- 
28,  46 
of    reorganization    committee, 

361 

of  trustee,  118 
Guaranteed  bonds,  293-308 
Guaranteed      by      endorsement, 
294 

Improvement     or     development 

bonds,  313 
Income,  anticipating  same,  209- 

210 

bonds,  329-334 
current,   229-230 
mortgaged,  229 
net,  230 


410 


INDEX 


Income — continued. 

of   road   before   default,   229- 

231,  83-84 

earned    during    operation,    by 
receiver,  209-210,  229-231 
by  trustee,   156,  231-234 
Indemnity   to   trustee,    120,    127, 

.  147,  155,.  159,   160 
Individual  holdings,  suits  there- 
on,  129-131 

Individual  interest,  of  reorgani- 
zation committee  in  prop- 
erty,  376-377 
of   trustee    in    pfoperty,    124- 

*25 

Injunction,    against    reorganiza- 
tion committee,  379-382 
stopping       foreclosure       sale, 

182-184 

against  trustee,   121 
Injuries  to  persons  or  property, 

231,  260 
caused     during     receivership, 

209-210 
sharing     in     assets,     209-210, 

231,  260 

Insolvency     of     road,     situation 
presented    by,    5-6,    234- 
236 
Instructions    to    receiver,     199- 

201 
to    reorganization    committee, 

377-379 

to  trustee,  135-137 
Insurance    of    mortgaged    prop- 
erty against  fire,  82-83 
Interchangeable    or    convertible 

bonds,   53-55 

Interest,  bonds  deposited  under 
mortgage,  78 

bonds    deposited    under    reor- 
ganization, 353-356 

certificates     of     deposit,     not 
payable  on,  355 

during  foreclosure,  45,  209 

foreclosure  for,  168 

overdue  coupons,  42-44 

priorities    among    claims    for, 
260-262 

registered  bonds,  52 


Intrinsic  value  of   railroad   se- 
curities, 2-4 
Invalid  bonds,  18 
Invalid  coupons,  46 

Joining  in  reorganization,  rights 
of  bondholders,  343-346 

Judgments,  258-259;  and  execu- 
tions, 253-254 

Leased     lines     affected     by     re- 
ceivership,   203-206 
Leases  of  rolling  stock,  affected 
by   receivership,    203-206 
Leasing  of  road,  bonds  resulting 

therefrom,  274-277 
by  trustee,   154-156 
instead    of    foreclosure,    168- 

169 

Legal  value  of  railroad  securi- 
ties, 4-7 

Liabilities    and    rights    of    trus- 
tees, generally,  89-90 
Liability,    for    co-trustees,    122- 

123 

of  receivers,  official  and  per- 
sonal, 219-220 
of    reorganization    committee, 

to    bondholders,    379-382 
for  co-members,  281-282 
to  third   persons,   379-382 
of  sureties  on  receiver's  bond, 

220 

of    trustee    for    acts    of    rep- 
resentatives,  119;   acts  of 
employees,  159 
to   bondholders,   119 
to  third  persons,  120 
relieved  by  mortgage,  from, 

119 
relieved    by    statute,    from, 

159-160 

under  reorganization  agree- 
ment, depositors  avoid- 
ing, 386-387 

Lien,  first  lien  bonds,  266-269 
mortgage  gives,  62-64 
mortgage   gives   is   preserved, 
86-87 


INDEX 


411 


Lien — continued. 

of   prior   mortgage   displaced, 
238-239,    246;    by    taxes, 
254-255 
Liens,   affected  by   receivership, 

193-195 

discussed,   62-63 
of   mechanics,   252-253 
on  property  sold,  176-177 
prior   and  later,  how  affected 

by  foreclosure,   178-180 
sharing  in  assets,  227-229 
underlying,   271-272 
Limitations,  on  amount  of  issue, 

69-72 
on   liability  of   reorganization 

committee,   379-382 
on     liability     of     trustee     by 
mortgage,  119,  by  statute, 
159-160 

statutes  of,  46-48 
Litigation,  bondholders  may  ap- 
pear in,   126-127 
by     bondholders     instead     of 

trustee,  127,  129 
trustee  usually  conducts,  126- 

128 
Losing    rights,    against    trustee, 

119-120,   124-125 
rights  to  set  aside  foreclosure 

sale,  183-184 
Lost  coupon  bonds  or  notes,  or 

coupons,   28-38 
Lost  registered  bonds,  48-49 

Majority,  advising  trustee,  125- 

137 
declaring      for       foreclosure, 

164-166 

changes  in  mortgage  by,  17 
changes   in   plan   by,    365-368 
reorganization  by,  344 
rights  to  declare  remedies  to 

be  pursued,  113 
rights   on   approval   or   rejec- 
tion of  plan,  360-364 
waiving  defaults,  17-18,  152- 

.  X53 

liens,  326 


Management  and  operation,  by 
receiver,  outline  of,  187- 
188 

by    trustee,    outline    of,    146- 

147,  154-160 

Marked  bonds,  14,  32-33 
Market  value  of  railroad  securi- 
ties, i 

Mechanics'    liens,   252-253 
Merger,   bonds   resulting  there- 
from, 274-277 

Minority,  changes  in  plan  by 
majority,  rights  of,  365- 
368 

foreclosure  may  be  forced  by, 
164 

majority  advising  trustee, 
rights  of,  135-137 

majority  declaring  for  fore- 
closure, 164-166 

reorganization  by  majority 
against  objections  of,  343- 
346 

remedies  of,  113 

rights  of  on  approval  or  re- 
jection of  plan,  360 

trustee  advised  by  majority, 
rights  of,  135-137 

trustee  forced  to  act  by,  165 
Mortgage,  affected  by  receiver- 
ship,  193-195 

closed,  69-72,  239-241 

consents  thereto,   68-69 

consolidated    bonds,    267-269 

conveys  property  to  trustee  as 
security,  97 

deed  of  trust  or,  56 

defective,  67 
valid  bonds,  66 

description  of,   57-59 

displacing  lien  of,  180,  238- 
239,  246,  254-^255 

effect  of,   58 

franchise  to  operate  included 
in,  59-62 

income  bonds,  320 

later,  affected  by  foreclosure, 
178-180 

lien,  62-64 

lien  displaced,   180,  238-239 


412 


INDEX 


Mortgage,    lien   displaced — con- 
tinued. 

by  operating  expenses,  246 
by  taxes,  254-255 
by      receiver's      certificates, 

180,  210-219 
meaning  of  word,  80 
open,    open-end,    69-72,    240- 

241 

parties  thereto,  68 
power   of   company  to   make, 

5976i 

opinion  of  counsel,  62 
pledge,  compared  with,  79-80 
purposes  of,  56,  68 
purchase  money,  255-257 
recording  of,  64-66 
remedies  to  enforce,  111-115 
successive,  238-239 
synopsis  of,  67 

terms    of    binding    on    bond- 
holders,   16-18 
trust  bonds,  267-269,  278 
valid,  bonds  void,   67 
void,  67 

affecting  bonds,  20 
bonds  valid,   66 
Mortgaged   property,   described, 

83-84 
usually  includes  the  franchise 

to  operate,    59-62 
insurance  against  fire,  82-83 
possession    by    railroad    com- 
pany,  78-82 

Mutilated  bonds,  notes,  or  cou- 
pons, 30-31 


Negotiability  of  bonds,  23-28 
Net  income,  84,  230 
New   charter,    a   form   of   reor- 
ganization,  335 

New     corporation,     after     reor- 
ganization,   394-395 
assuming  payment  of  receiv- 
ers'  certificates,  403-404 
bound  to  issue  stock,  bonds, 

etc.,   397-400 

damages  caused   during  or 
prior  to  receivership,  404 


New  corporation — continued, 
debts   and   contracts   of   in- 
solvent     road,      176-177, 
402-404 
taking  over  purchased  road, 

400-402 

New  management,  a  form  of  re- 
organization, 338 
New     mortgage     before     prior 
mortgage  bonds   out,   245 
Notes   and  bonds,  compared,   n 
described,  10 

sharing  in   assets,  262-265 
Notice,   of  filing   reorganization 

plan,   358-359 

of  foreclosure  sale,   181-182 
Non-cumulative    income    bonds, 

330-331 
Numbered  bonds,  25,  241-243 

Obligations,      direct      or      col- 
lateral, 76 

Official     liability     of     receiver, 
219-220 

Open-end  mortgage,  open  mort- 
gage, 69-72,  240,  241 

Operating    expenses,    may    dis- 
place   lien    of    mortgage, 
1 80,  245-250 
sharing  in  assets,  230-231 

Operation    of    road    by    trustee, 

146-147,   154-160 
control  by  bondholders,  155 

Opinion   of   counsel    as  to  bond 
and  mortgage,  61-62 

Option    of    bondholders    to    de- 
clare principal  due,  150- 

151 
Original      construction,      claims 

for,   250-252 

Outline     of     foreclosure     pro- 
cedure,   162-163 
of  receivership,  187-188 
of    reorganization    procedure, 

338-340 
Overdue       coupons,       affecting 

bonds,  40-42 
interest  thereon,  42-44 
Overissued  bonds,  19-20,  243 
protection  against,  69 


INDEX 


413 


Ownership  of  bonds,  presump- 
tion of,  33-34 

Paid    coupons,    cancellation    of, 

92-93 
Papers   or   documents   necessary 

for  trusteeship,  88 
Participating  bonds,  279-280 
Participation   in   reorganization, 

rights      of      bondholders, 

342-343 
Parties,  to  mortgage,  68 

to    reorganization    liable    for 

expenses,   386-387 
Payment,   of  bond   and   interest, 
no    reduction    for    taxes, 
etc.,   91 

in  gold  coin,  91 
of  coupons,  37-38 
effect  of,  38-40 
or     interest     during     fore- 
closure, 45 
of      interest      on      registered 

bonds,  50-52 

Penalty  as  condition  for  extend- 
ing time  to  participate  in 
reorganization,    351-352 
Personal    injuries,    claims    for, 

209-210,  231,  260 
Personal    interest,    of    reorgan- 
ization       committee       in 
property,  376-37? 
of    trustee    in    property,    124- 

125 
Personal    liability,    of    receiver, 

219-220 
of    reorganization    committee, 

379-382 

of  trustee,  119-120,  159-160 
Personnel       of       reorganization 

committee,  376 
Persons   who   may   purchase    at 

foreclosure,   172-173 
Place   of   foreclosure   sale,    181- 

182 

Plan  for  reorganization,  aban- 
doning same  after  adop- 
tion, 364-365 

construed,    changed,    etc.,    by 
committee,  370-372 


Plan  for  reorganization — cont. 
filing  of,  358-359 
how     formulated     and     sub- 
mitted,  360-364 
right  to   examine,   358-359 
submitting  same  for  assent  or 

dissent,    360-364 
synopsis  of,  356-358 
when  it  takes  effect,  364-365 
Pledge  and  mortgage  compared, 

79-80 

Possession,     and     operation     of 
road  by  trustee,   146-147, 
154-160 
controlled    by    bondholders, 

155 

of  mortgaged  property  by 
railroad  company,  78- 
82 

of  securities  deposited  under 
mortgage,  78 

Postponing  action  under  the 
mortgage,  111-112,  148- 
150 

Powers,  of  railroad  company  to 

issue  bonds  or  notes,  8-9 

controlled    by    commissions, 

charter,  consents,   etc.,   9- 

10,  68 

of    receiver,    generally,   when 

operating   road,   200-202 
of    reorganization    committee, 

368-370 

of  trustee,  general  scope  of, 
89-90,  131-132 

Preferences  given  receiver's 
certificates,  210-219 

Preferences  given  receiver's  ex- 
penses, 209 

Preferences  given  reorganiza- 
tion committee's  expenses, 
375-376 

Preferences  given  trustee's  ex- 
penses, 158 

Preferential  bonds,   326-327 

Preferred,   stock,   254 
stockholders,  16 

Preparing  plan,  powers  of  re- 
organization committee, 
370-372 


INDEX 


Preserving  lien  of  mortgage,  86- 

87 
Preventing      foreclosure      sale, 

182-184 

Principal  of  bonds,  may  fall 
due  on  default  of  inter- 
est, 150-151 

only  registered,  coupons  nego- 
tiable, 52-53 

Priorities,  among  coupons,  44- 
46,  260-262 

between  principal  and  inter- 
est, 92,  260-262 

waiving  of,  238-239 

what  is  meant  by,  236 
Prior  lien  bonds,  326-327 
Proceeds  of  sale  by  trustee,  how 

distributed,    161-162 
Profit  sharing  bonds,  279-280 
Property,   after  acquired  clause, 
85-86 

conveyed  to  trustee  by  mort- 
gage, 77 

damages  to,  claims  for,  209- 
210,  260 

reorganization  committee  ac- 
quiring, 374-375. 

sale  of,  subject  to  prior  liens, 
176-177 

taken  over  by  new  corpora- 
tion, 400-402 

that  is  usually  mortgaged,  83- 

84 

Purchase,  money  mortgage,  255- 
257 

of  road  by  reorganization 
committee  or  bond- 
holders, 383-385 

of  trust  property,  by  reorgani- 
zation committee,  376-377 
by  trustee,  124-125 
Purchasers,    certain,    barred    at 
foreclosure,   172-173 

default  of  in  completing  pur- 
chase, 384 

foreclosure  sale,  rights  of, 
173-175 

liability  of,  for  debts  and  con- 
tracts of  insolvent  road, 
176-177 


Purchasers — continued. 

liability  of,  for  debts  and  con- 
tracts   and   certificates   of 
receiver,  177-178 
taking     property     subject     to 

liens,   176-177 
Purpose  of  mortgage,  68 


Qualifications,  of  receiver,   198 

of  trustee,  118,  141 
Quasi-public  corporation,  60-61, 
248 


Reasons    for    trusteeship,     117- 
iil 

Receiver,    accounting    by,    220- 

221 

advised  by  court,  201 
compensation  of,  223-224 
compromising       or        settling 

claims,  201 
contracts    of    insolvent    road, 

including  leases,  car  trust 

agreements,  affecting  the, 

203-206 

controlled  bv  court,  199-200 
discretionary  powers  of,  202 
expenditures     by,      generally, 

206-207 

for  large  sums,  207-209 
operating    the    road,     powers 

and  duties,  200-202 
.qualifications,   198-199 
removal  of,  221-223 
represents  the  court,  199-200 
suits   against,   193-195 
unusual  contracts  by,  207-209 
unauthorized  acts  of,  201 
when   appointed,   188-191 
who  are  chosen,  198-199 
Receiver's  bond,  192-193 
Receiver's   certificates,    210-219 
assumed   by  new  corporation, 

403-404 

may    displace    lien    of    mort- 
gage,  i 80,  210-219 
reorganization  committee  may 

consent  to,  376 


INDEX 


415 


Receivership,  agreement  of  rail- 
road company  with  rela- 
tion  to,    112-113 
ancillary,   195-197 
attitude     of     courts     toward, 

191-192 
branch  or  subsidiary  line,  197- 

198 

consents     of     parties     in     in- 
terest,   192-193,    88-89 
generally,   187-188 
effect    of,    on    existing    liens, 

193-195 
expenses  of,  what  constitutes, 

209 

grounds  therefor,  188-191 
income   during,   209-210 
parent  company,   197-198 
subsidiary  company,   197-198 
termination  of,  224-225 
Recording  or  filing  of  mortgage, 

64-66 
Redemption,       and       exemption 

laws,  waiving  of,  88-89 
by  railroad  company,  153 
equity  of,    178-180 
Redeeming  bonds,  98-100 
Refunding,   bonds,   101-105 
mortgage   bonds,  272-274 
plans,   101-105 
Registered  bonds,  14,  48-50 
converting  coupon   bond   into, 

50-52 

interest  on,  52 
as  to   principal  only,  52-53 
transfer  of,  14,  50-62 
Registered  coupons,  53 
Registration,  act  of,  49 

of  certificates  of  deposit,  354- 

355 
effect  of,  48-49 

Reissued   bonds,   243-244 

Rejection,    of    changes    in    reor- 
ganization plan,   365-368 
of    reorganization    plan,    360- 
364 

Relation  between  bondholders 
and  trustee,  generally, 
116-117 

Removal  of  receiver,  221-223 


Removal  of  trustee,  137-139 
Replacing  mortgaged  parts,   81 
Replacing     securities     deposited 

under  mortgage,  81-82 
Remedies,         of         bondholders 

against   trustee,    121-125 
to     enforce     mortgage,     ni- 

"5 

trustee  pursues,   132-134 
Rentals     received     by     trustee, 

161 

Reorganization  agreement,  rights 
of  bondholders  to  ex- 
amine, 342-343 

synopsis  of,  349-352 

termination  of,  390-393 
Reorganization,         bondholders 
right    to    participate     in, 
generally,  342-346 

bondholders  right  to  refuse 
to  participate  in,  343 

by  bondholders  alone  or  with 
other  creditors,  stock- 
holders, 346-349 

bonds    growing   out   of,    324- 

325 

different  forms  of,  335-338 
expenses   of,   how   paid,    393- 

394 

financing  of,   339-340 

majority  against  objections  of 
minority,  343—346 

must  be  fair,  340-342 

plan,  synopsis  of,  356-358 

procedure,  outline  of,  338- 
340 

time  within  which  it  must  be 
completed  or  deposited 
securities  returned,  377- 
379 

Reorganization  committee,  ac- 
counting and  discharge, 
378,  382 

bondholders  bound  by  acts  of, 

385 

changing  mortgage,   17 
changing  plan  or  agreement, 

365-368 

compensation  of,  may  be  for- 
feited, 392 


416 


INDEX 


Reorganization  committee— cont. 
discretionary  powers  with  re- 
lation to  plan,   360-361 
duties  of,  general  scope,  377- 

379 
expenditures,     expenses     and 

debts,  375-376 
good  faith  of,  361 
personal  interest  in  property, 

376-377 

personal   liability,  379-382 
personnel   of,   375 
plan,   abandoning  same,  364- 

365 
declaring    same    operative, 

364 
discretionary    powers    with 

relation  to,   360-361 
powers  of,   general   scope  of, 

368-370 
over  deposited  bonds,  373- 

374 
to  construe,  remedy,  change, 

prepare,     adopt,     declare 

operative,    abandon   plan, 

370-372 

purchasing  road,  383-385 
purchasing  with  own  money, 

384 

prior  liens  paid  by,  375 
property     acquired     by,     374- 

375 

receivers  certificates,  consent- 
ing to,  218 

remedies  of  bondholders,  pur- 
sued by,  374 

representatives    may    be    em- 
ployed by,  370 
waiving  defaults,   17-18 
Repairs  to  mortgaged  property, 
company  agrees  to  make, 
80-82 

Repossession    by    railroad    com- 
pany, iio-ui,  153 
Resale  of   road  under   reorgan- 
ization, 386 
Residence  of  railroad  company, 

17 . 
Resignation,    by    receiver,    221- 

223 


Resignation — continued. 

by    reorganization    committee, 

376 

by  trustee,  139^141 
Return    of    securities    upon   ter- 
mination   of    reorganiza- 
tion, 387-390 

Right  of  way  claims,  257-258 
Rights,  liabilities  of  trustee,  89- 

90 

Rolling  stock,  what  it  is,  204 
lease  of,  203-204 
car    trust    agreements    cover- 
ing,   205-206,    316-323 
Rules  for  distribution  of  assets, 
227-229 


Sale,  by  trustee,  details  of,  161- 

162 

proceeds  of,  114-115 
control  by  bondholders,  160- 

162 

notice  of,  181-182 
stopping,  preventing  or  set- 
ting aside,   182-184 
subject  to  liens,  176-177 
terms  of,   184-185 
under  foreclosure,  167-170 
conditional,  255-257 
or  lease  of  property,  a  form 

of  reorganization,  335 
Scaling,  328-329 

form  of   reorganization,   337- 

338 
Second    mortgage    bonds,    267- 

269 

Secured  and  unsecured  creditors, 
sharing  in  assets,  227- 
229 

Securities  of  new  corporation, 
after  reorganization,  397- 
400 

Security  for  coupons,  44-46 
Selection  of  trustee,   131-132 
Serial  bonds,  100-101,  243 
Serial  numbers,  25,  241-243 

alteration  of,   30-31 
Series,   bonds   in,   100-101,  240- 
241,  243 


INDEX 


417 


Setting    aside    foreclosure    sale, 

182-184 

Several  coupons,   34-36 
Sinking  fund  arrangements,  93- 

98 

Stamped  bonds,  308-309 
Stock,  of  consolidated  company, 

289 

of  new  corporation,  after  re- 
organization, must  be  is- 
sued, 397-400 

Stockholders,      becoming      such 
upon  conversion  of  bonds 
into  stock,   105-110 
bondholders     and,     compared, 

15-16 

consents  of  to  mortgage,  68-69 
interests  of  in  assets  of  road, 

15 

joining       in       reorganization, 

372-373 

reorganization  by,  with  bond- 
holders or  other  creditors, 

346-349 
rights  of  in  insolvent  road, 

346-349 
terms  upon  which  they  may 

join   reorganization,    346- 

349 

Stolen  coupon  bonds  or  notes,  or 
coupons,  28-30 

Stolen  registered  bonds,  48 

Stopping  foreclosure  sale,  182- 
184 

Straw  bidding,  184-185 

Submitting  plans  for  assents  or 
dissents,  360-364 

Surrendering  certificates  of  de- 
posit upon  withdrawal 
from  reorganization,  387- 
390 

Subsidiary  roads,  control  of, 
bonds  resulting  from, 
274-277 

financing  of,  283-286 
receivership  of,   197-198 

Succession  by  continuing  trus- 
tee, 123 

Suits,  against  receiver,  193-195 
on  detached  coupons,   35 


Sureties  on  receiver's  bond,  193 

liability  of,  220 

Synopsis    of    mortgage,    67-115, 
general  description,  57-59 
of      reorganization      agree- 
ment, 349-352 

of   reorganization  plan,   356- 
358 


Taxes,  lien  thereof  may  displace 
that  of  mortgage,  180, 
254-255 

no  reduction  from  bond  or  in- 
terest, 91 

Temporary  bonds,  12-13 
Terminal  bonds,  310-312 
Termination,  of  receivership, 

224-225 
of    reorganization    agreement, 

390-393 
Terms  of  foreclosure  sale,  184- 

185 

Third  mortgage  bonds,  267-269 

Three  usual  remedies  to  enforce 

mortgage,    133-134,    '46- 

H7 

Time,  of  foreclosure  sale,   181- 

182 

within  which  assents  or  dis- 
sents from  plan  must  be 
filed,   371-372 
within  which  parties  may  join 

reorganization,   351,   372 
penalty,   352 

within  which  new  corpora- 
tion, after  reorganization, 
shall  issue  securities, 
397-400 

within    which    reorganization 
must  be  completed  or  de- 
posited      securities       re- 
turned,  377-379,   387-390 
Transfer,    of    bonds,    generally, 

13-14 

of  certificates  of  deposit,  354 
of  coupons,  32-34 
of  registered  bonds,  50-52 
Transferring  lien  to  proceeds  of 
sale,  176-178 


418 


INDEX 


Trust     bonds,     first     mortgage, 

267-269 

Trustee,    advised    by    court,    by 
majority   bondholders,   by 
legal   counsel,    135-137 
changing  mortgage,   17 
compensation   of,   141-142 
discretionary  powers  of,   134- 

135,. 154 

distribution  by  of  proceeds  of 
operation    of    road,    156- 

.157 
duties  of,  generally,  132-134 

expenses  of,  142-144,  157- 

158 

forecloses  usually,  164-166 
foreclosure  preferred  by,  185- 

186 

indemnity    for,    155,    159, 

1 60 
liability    of,    to    bondholders, 

155 

to  third  persons,  155 
liability,     relieved     from,    by 

statute,        159-160;        by 

mortgage,   119 
losing   right  to   litigate,   127- 

128 

minority   may   direct,  165 
powers  of,  general  scope,  131- 

132 
purchasing      at      foreclosure, 

when  permitted,  172-173 
qualifications  of,   147 
remedies  of,   132-134 
removal  of,  137-139 
resignation  of,   139-141 
rights   and    liabilities   of,   89- 

90 
selling     property     to     satisfy 

mortgage,    160-162 
selection  of,  131-132 
waiving   defaults,    17-18,    112, 

152-153 

waiving    rights   of   bondhold- 
ers, 239 

who  is  chosen,  118 
Trustee's    certificate,    check    on 

overissue,  70 
forgery  of,  24 


Trustee's    certificate — continued. 

form  of,  75 

generally,  90 

Trusteeship    created     by    mort- 
gage, 77 

reasons  therefor,  177 

Underlying  liens,  271-272 
Unification,  unifying  bonds,  270 
Unsecured     and     secured    cred- 
itors, 227-229 

Unsecured    bonds,    see    Deben- 
tures 
Unsecured    claims,    affected    by 

foreclosure,    178-180 
shares  in  assets,  227-229 
Unsecured     creditors,     of     con- 
stituent     companies      af- 
fected     by      consolidated 
mortgage,  288 
protected     in     reorganization, 

346-349 
Unusual  contracts  of  receiver, 

207-209 
Upset  price,  184 

Vacancies    in    trusteeship,    139- 

141 

Valid  bonds,  void  mortgage,  66 
Valid  mortgage,  void  bonds,  66 
Validity  of  bonds,  18 
Valuation  laws,  waiving  of,  88 
Value  of  railroad  securities,  i 
intrinsic  value,   2-4 
legal  value,  4-7 
market  value,   i 
Variation,    between    bond    and 

coupon,  36 
between  bond  and  mortgage, 

18 

Void  bonds,  18-20 
Void   mortgage,   17 
Voting  power  of  stock  deposited 

under  mortgage,  78 
Voting  trust,  399-400 

Waiving,    defaults,    17-18,    112, 

152-153 

lien,    a    form   of    reorganiza- 
tion, 336-339 


INDEX  419 

Waiving — continued.  Withdrawing,    from    agreement 

or  losing  rights  against  trus-  of     reorganization,     387- 

tee,   124-125,   119-120  390 

priorities,  238-239  from      reorganization,      upon 

redemption      and      exemption  changes  in  plan,  367 

laws,  88-89 


1 J     '    • •     "    I'll      I II    I  1 1  II     I     III       II 

A     000  678  631     3 


